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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2001Commission File No. 0-27742
CYLINK CORPORATION
(Exact name of registrant as specified in its charter)
California 95-3891600
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3131 Jay Street
Santa Clara, CA 95054
(Address of principal executive offices)
(408) 855-6000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES _X__ NO ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of the Common Stock on March 27,
2002, as reported by the Nasdaq National Market, was approximately $36,828,000.
Shares of Common Stock held by each officer and director and by each person
who owns 5% or more of the outstanding Common Stock, based on Schedule 13G
filings, have been excluded from the computation in that such persons may be
deemed to be affiliates. This determination of affiliate status is not a
conclusive determination for other purposes.
As of March 27, 2002, there were 33,035,017 shares of the Registrant's
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the Registrant's Proxy Statement for its Annual Meeting of
Shareholders (the "Proxy Statement") to be held on May 15, 2002, are
incorporated by reference in Part III of this Form 10-K to the extent stated
herein.
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TABLE OF CONTENTS
FORWARD LOOKING STATEMENTS ................................................. 1
PART I ..................................................................... 2
ITEM 1. BUSINESS ......................................................... 2
ITEM 2. PROPERTIES ....................................................... 16
ITEM 3. LEGAL PROCEEDINGS ................................................ 16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .............. 17
PART II .................................................................... 18
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS .............................................. 18
ITEM 6. SELECTED FINANCIAL DATA .......................................... 18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS .............................. 19
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK ............................................................. 24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ...................... 25
Independent Auditors' Report ............................................ 26
Consolidated Balance Sheets ............................................. 27
Consolidated Statements of Operations ................................... 28
Consolidated Statements of Shareholders' Equity and Comprehensive Loss .. 29
Consolidated Statements of Cash Flows ................................... 30
Notes to Consolidated Financial Statements .............................. 31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE .............................. 47
PART III ................................................................... 48
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ............... 48
ITEM 11. EXECUTIVE COMPENSATION ........................................... 48
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT ................................................... 48
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ................... 48
PART IV .................................................................... 48
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND
REPORTS ON FORM 8-K .............................................. 48
SIGNATURES ................................................................. 50
SCHEDULE II ................................................................ 51
INDEPENDENT AUDITORS' CONSENT .............................................. 52
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FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K and certain information incorporated herein
by reference contain forward-looking statements within the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995. All
statements included or incorporated by reference in this Annual Report, other
than statements that are purely historical are forward-looking statements. Words
such as "anticipates," "expects," "intends," "plans," "believes," "seeks,"
"estimates" and similar expressions also identify forward-looking statements.
These forward-looking statements, which include statements about the growth of
the network security industry; future demand; product performance; Cylink's
expectations, objectives, anticipations, intentions and strategies regarding the
future, expected operating results, revenues and earnings and current and
potential litigation are not guarantees of future performance and are subject to
risks and uncertainties that could cause actual results to differ materially
from the results contemplated by the forward-looking statements. Forward-looking
statements in this Annual Report on Form 10-K include, without limitation:
* belief that large enterprises will continue to use their private networks
and shared data services rather than migrate all of their network
operations to the Internet
* statements regarding release of a major upgrade to the NetHawk, including
numerous networking features in Q2 2002
* belief that PrivaCy Manager's ease of management is a competitive advantage
* expectations regarding license and revenue with the USPS
* belief that, if necessary, Cylink will be able to locate another source for
components and subsystems for products the Company manufactures at our own
facilities
* plans to cut costs in accordance with its lower revenue will be sufficient
to fund operations for 2002
* belief that the Company's principal sources of liquidity may satisfy the
Company's current anticipated working capital and capital expenditure
requirements through at least the next twelve months
* belief that cost reductions are sustainable for the rest of 2002
* belief that Cylink's current facilities are well maintained and are
adequate for the foreseeable future
* belief that the Company has meritorious defenses and adequate insurance for
the damages claimed in shareholder litigation actions and the Company's
intentions to defend itself vigorously
* belief that existing cash balances and prospective borrowing may be
sufficient to fund operations through 2002
* belief that the Company will satisfy the financial covenant or renegotiate
that covenant to which its line of credit is subject during the term of the
loan
The above forward-looking statements and any expectations based on such
forward-looking statements are subject to risks and uncertainties and other
important factors. Any of Cylink's actual results could differ materially from
those included in such forward-looking statements. The above forward-looking
statements are subject to the risks and uncertainties further discussed under
"Item 1, Business -- Risk Factors" beginning on page 9.
All forward-looking statements included in this document are based on
information available to Cylink on the date hereof, and Cylink assumes no
obligation to update any such forward-looking statements. Shareholders are
cautioned not to place undue reliance on such statements, which speak only as of
the date of this Annual Report. The reader should also consult the cautionary
statements and risk factors listed from time to time in Cylink's Reports on
Forms 10-Q, 8-K, 10-K and its Annual Reports to Shareholders for other trends,
risks or uncertainties which could cause the Company's results to differ from
those expressed in such forward looking statements.
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PART I
ITEM 1. BUSINESS
We develop, manufacture, market and support a comprehensive portfolio of
hardware and software security products for mission-critical private networks
and business communications over the Internet. We believe our cryptographic
products provide the most secure, flexible and easily managed solutions for
expanding our customers' private and public commercial networks.
Our solutions offer competitive advantages to our customers by lowering the
cost of deploying and managing secure, reliable private networks, while enabling
use of the Internet for trusted transactions with business partners and
customers. We provide "drop-in" hardware encryption products that are easily
deployed within customers existing high-speed data networks known as Local Area
Networks ("LANs") and Wide Area Networks ("WANs"), including Virtual Private
Networks ("VPNs") that use the Internet. Our products are designed as
"appliances" that can be connected quickly and easily to customer networks
without costly changes in their networks' configuration.
Our products are centrally managed by our proprietary software management
system, PrivaCy Manager, that allows the customer's network security manager to
remotely configure and operate all of our products without risk of tampering by
other network operations personnel. We also believe the separation of
responsibility for security management from other network operations
differentiates our solutions from vendors of general purpose networking
equipment by allowing our customers to carefully control access to their network
security policies.
We create trust in our customers' networks by securing the access, privacy
and integrity of information when it is transmitted over their LANs, WANs, and
the Internet. These trusted solutions enable our customers to merge their
operations and transactions onto existing networks, maximize network use, reduce
the costs of operations, and expand businesses. Our customers include leading
Fortune 500 corporations, multinational corporations, financial institutions and
numerous agencies within the United States Government. We estimate that more
than $7.0 trillion worth of financial transactions are transmitted each business
day over networks secured by our encryption appliances and management software.
Industry Background
The need for dependable data services such as T1, T3, frame relay and
Asynchronous Transfer Mode ("ATM") for WANs, the explosive use of the Internet
for business communications, and the continued growth in LANs create a demand
for reliable, easily managed security solutions. All of these services,
including switched private networks as well as the public Internet, are
essential to modern network operations. Although some vendors of network
security products focus exclusively on VPNs for the Internet, we believe network
security solutions for large enterprises must address all of these network
services.
We believe that large enterprises will continue to use their private
networks and shared data services rather than migrate all of their network
operations to the Internet. Although VPN services over the Internet are ideal
for intermittent communications with third parties, businesses continue to rely
on more dependable, switched services for their mission-critical infrastructure
such as finance, engineering and manufacturing operations. Businesses do not
want to expose their more critical communications to additional risks of
interrupted communications, lost connections and denial of service attacks
inherent to the Internet. Money center financial institutions, Fortune 500
companies that transmit highly valued intellectual property, and Government
departments and their agencies, cannot and will not rely exclusively on the
Internet for all of their networking architecture.
Competing vendors of data security products typically emphasize one form of
communications service or a specific defense to a common threat. For example,
firewall vendors use filtering technology to control external access from the
Internet. Intrusion detection, or intrusion prevention as some products are
known, are intended to alert network operators of attempts to penetrate
customers' networks. Similarly, anti-virus products address the prevalence of
virus attacks that proliferate through the Internet, and
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migrate into private networks through their users' computers. Each of these
products provides a valuable, but incomplete, answer to meeting the varied
threats to network communications.
Today, large networks contain hundreds, if not thousands of points of
vulnerability, which can make passwords, routing tables, network architecture
and other attack information available. Corporate communications may pass
through dozens of countries, over satellites, numerous operating systems in
computers and routers, and through a variety of organizations or communications
providers and their premises. Consequently, multiple parties have access, or can
acquire access, to proprietary data within these networks.
Because of this exposure to unauthorized access and data tampering, all
communications paths must be considered either "trusted or un-trusted." We
believe that encryption, by protecting the privacy of the information, ensuring
the integrity of the data and authenticating the source and destination of the
communication, is the most reliable technology for ensuring a trusted network.
We further believe encryption should be the first line of defense in the
network's security strategy, with firewalls, intrusion detection and anti-virus
solutions providing additional defense "in-depth" for communications received
from remaining, un-trusted sources.
Another advantage to using our encryption appliances and management
software is our unrivaled experience with implementing public key technology to
support unlimited deployment of our products with the growth of our customers'
networks. Prior to the invention of public key cryptography at Stanford
University in 1976, the expense of managing and distributing unique
cryptographic "keys" limited the use of cryptographic solutions to governments
and very large financial institutions that could afford the cumbersome manual
methods for handling keying material. Public key cryptography offered the first
economical method for electronically automating cryptographic key management,
drastically reducing the cost of owning and operating cryptographic devices. In
addition, public key cryptography enables the use of "digital certificates" to
establish correspondents' identities, the authenticity of their communications
and their privileges within a network. Public key technology is now the industry
standard for managing and authenticating encryption devices, and we were one of
the first companies to recognize its value and create products to implement it.
Company History
Founded in 1983, we were the first company to focus exclusively on public
key-based security solutions for high value networks. By 1985 we introduced our
first line of high-speed link encryptors to secure private leased lines. During
the next ten years we marketed a variety of public key encryption devices,
including fax encryptors and secure phones. In the mid `90s we began introducing
our first security appliances for frame relay services and the Internet. In the
summer of 2000 we released NetHawk, our first VPN appliance for the Internet.
Later that summer, we acquired Celotek Corporation, the premier supplier for the
ATM encryption market.
In February and March of 1996, we completed our initial public offering and
our Common Stock began trading on the NASDAQ National Market under the symbol
CYLK.
We operate in one industry reportable segment -- network security products.
Our principal operations outside of the United States consist of sales and
service offices located in the United Kingdom and several other countries in
Europe and the Far East. See Note 15 of the Notes to Consolidated Financial
Statements for geographic area information.
Our Products and Services
We provide a comprehensive portfolio of integrated security solutions. Our
public key-based solutions include the NetHawk, which creates a secure virtual
private network, or VPN, for transmitting high-value information. Our link,
frame relay and ATM security appliances can be deployed easily throughout the
network to assure the integrity and privacy of information transmitted over
private leased lines or shared network resources. These network security
appliances are designed to secure existing networks without reducing performance
or requiring modifications to customers' existing network hardware or software.
This ease of "drop in" integration is accomplished with a broad range of
hardware and
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software implementations of network interfaces, which enable our security
appliances to connect to most networks in use throughout the world. We also
offer a unified management platform for all of our security appliances to
authenticate these devices, configure their use and centrally manage their
operation. Our solutions include our public key infrastructure, or PKI, for
managing the digital identities and privileges of all correspondents on the
customer's network.
The following table sets forth our principal products and services:
Products and Services Description
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Internet Security--VPNs
NetHawk High-Performance, Highly Scalable IPSec VPN Solution
WAN Security
Cylink Link Encryptor High-Speed Appliance For Point-To-Point Communications
Cylink Frame Relay High-Speed Appliance for Frame Relay Networks
Cylink ATM Encryptors High-Speed Appliance for ATM Networks
Security Network Management
PrivaCy Manager Software For Managing Cylink Security Devices
Public Key Infrastructure
NetAuthority Highly Scalable Software For Trusted Authentication
Internet Security -- VPNs
NetHawk. The NetHawk VPN is our latest security solution for communications
over the Internet. NetHawk is a dedicated, standalone IPSec device that enables
encryption of thousands of simultaneous connections at full line speeds from 10
to 100 Mbps, using strong, Triple-DES encryption. As with all of our products,
NetHawk uses public key cryptography for fully automated key management. NetHawk
began shipping to customers in June 2000. A major upgrade to the NetHawk,
including numerous networking features is scheduled for release in the second
quarter of 2002.
WAN Security
Cylink Link Encryptors. The Cylink Link Encryptor ("CLE") and its
predecessor, the CIDEC family of products, are network appliances that form a
complete line of link encryptors for securing sensitive data transmitted over
high-speed, point-to-point or dial-up communication links. Our CLE's secure data
communications at speeds up to 52 Mbps over private and public networks and
support most widely used data link protocols. At the end of 2000, Cylink
introduced the CLE-HSSI, a link encryptor with high-speed serial integration,
which we believe to be the fastest link encryptor on the market. We introduced
the CLE-T3 in the fourth quarter of 2001 that provides speeds up to 45 Mbps.
Cylink Frame Encryptor. The Cylink Frame Encryptor ("CFE") is a network
appliance that provides high-speed, high-level security for frame relay
networks. We offer three models that encrypt data at speeds of up to 45 Mbps and
are scalable across a wide range of networks and applications. It positively
identifies other Frame Encryptor units and will not accept frames from
unauthorized sources. Once a connection is made, data is encrypted as it flows
between nodes and different encryption keys are used for each virtual circuit.
In the fourth quarter of 2001, we introduced the CFE-HSSI, the fastest frame
relay encryption device in the industry with speeds up to 52 Mbps.
Cylink ATM Encryptor. The ATM Encryptor is a family of security gateways
for ATM networks and can be deployed in T1, E1, T3, E3, OC3c and OC12c networks.
The Cylink ATM Encryptor creates a virtual trusted network that provides data
privacy and access control for connections between trusted ATM local area
networks across public ATM wide area networks. Cylink's ATM Technology Center,
located in Raleigh, North Carolina, is devoted exclusively to the design and
production of ATM encryptor equipment.
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Security Network Management
PrivaCy Manager. PrivaCy Manager provides a Java-based, security management
platform for all of our Internet Security and WAN Security appliances. PrivaCy
Manager's graphical representation of the network's topology and its
point-and-click interface simplifies the tasks of configuring, modifying and
managing network security. Furthermore, PrivaCy Manager can implement a broad
range of security policies for determining access to network security devices,
while preventing unauthorized devices from masquerading as legitimate devices
within a user's network. We believe that PrivaCy Manager's ease of management is
one of our competitive advantages in helping our customers to lower their total
cost of network security.
Public Key Infrastructure
NetAuthority. NetAuthority is a highly scalable, standards-based public key
infrastructure, or PKI, system that enables a wide variety of applications
including secure email, secure web browsing, VPN, and e-commerce. NetAuthority
consists of a Certificate Authority, Registration Server, Registration Authority
and a PKI Toolkit, that together provide all the components necessary to make
applications and devices PKI enabled.
Sales, Marketing and Customer Support
We market our products primarily through our direct sales force, value
added resellers and international distributors. Our direct sales force operates
from our headquarters in Santa Clara, California and other regional sales
offices located in the United States, Europe, and the Far East. Our sales force,
engineers and technical personnel work closely with customers to determine
system security and network configurations that meet the customers' needs.
International sales are made primarily through our headquarters in Santa
Clara, California, three foreign sales offices, and numerous distributors. We
seldom have long-term contractual relationships with our distributors and,
therefore, generally have no assurance of a continuing relationship within a
given market.
To date, the majority of our customers for our network security products
have been Fortune 1000 companies, financial institutions, government agencies
and telecommunication carriers who rely on our WAN Security Products to encrypt
and secure their WANs operating over private leased lines and packet switched
networks.
We believe that customer support is essential to developing and maintaining
good relationships with our customers. Our support personnel are responsible for
providing installation, technical training, technical support, on-site support
and repair services. We offer end-users a number of different levels of support,
maintenance and service options, including extended warranties, emergency
replacement services, product upgrades and on-site support. We offer service and
support from our headquarters and from service and support centers in New
Jersey, the United Kingdom, Brussels, and Singapore. Telephone support is also
available twenty-four hours per day, seven days per week, through a toll-free
hotline.
Our products developed or manufactured in the United States are subject to
the export control laws of the United States and regulations promulgated by the
U.S. Department of Commerce. Certain limitations applied by the Commerce
Department affect the functionality of the products, which may be exported to
foreign governments. In addition, these United States export laws prohibit the
export of encryption products to certain hostile countries.
Backlog
Orders for our products are usually placed by customers on an as-needed
basis and we typically ship products within thirty to sixty days of receipt of a
customer's firm purchase order. Our backlog consists of all orders received,
where the anticipated shipping date is within twelve months. Because of the
possibility of customer changes in delivery schedules or cancellation of orders,
our backlog as of any particular date may not be indicative of sales in any
future period. We seldom maintain long-term
5
contracts with our customers that require them to purchase our products. Our
backlog for continuing operations as of December 31, 2000 and 2001 was
approximately $2.3 million for both periods.
Manufacturing
Our manufacturing operations consist primarily of component procurement,
final assembly and test, and quality control of subassemblies and systems. Our
standalone software products are replicated at our facilities. We generally use
domestic independent contractors to manufacture and assemble printed circuit
boards and the metal packaging for our hardware appliances. The manufacturing
process enables us to configure the hardware and software in combinations to
meet a wide variety of customer requirements. We install our software into the
electronically programmable read-only memory of our products to maintain quality
control and security, and perform "burn-in" procedures and functional tests, as
well as comprehensive inspections to ensure the quality and reliability of our
products.
Our product designs are proprietary but generally incorporate
industry-standard algorithms and hardware components. However, certain
semiconductor devices, electronic components and subassemblies are currently
purchased from sole source suppliers. Specifically, each of our custom designed
integrated circuits, including our encryption circuits, are manufactured by one
supplier at a time. Our sole source suppliers include American Microsystems,
Inc., Atmel Corp., National Semiconductor and Chip Express. Certain other
components are currently available or acquired from only a limited number of
suppliers. Our ability to timely deliver our products is highly dependent upon
the availability of quality components and subsystems from these suppliers. We
also depend in part upon subcontractors to manufacture, assemble and deliver in
a timely and satisfactory manner. A failure to find an adequate source of supply
for components selected by our design engineers for new products or a
significant interruption in the delivery of sole source items from existing
suppliers could have a material adverse effect on our results of operations.
Although we believe, if necessary, that we will be able to locate another source
for components and subsystems for products we manufacture at our own facilities,
the delay in receiving supplies and in production of our finished goods could be
significant.
In the third quarter of 2001, we entered into a development and supply
agreement with Biodata Information Technology AG ("Biodata") to replace our
previous OEM supplier of ISDN encryption products, DICA Technologies, Inc.,
following DICA's declaration of insolvency in the first half of 2001. In
February of 2002, Biodata also declared insolvency, and we notified Biodata of
our decision to terminate the agreement. Due to the failure of both of our
suppliers, we decided to discontinue all further sales of and support for an
ISDN product line.
Intellectual Property and Other Proprietary Rights
We rely on patents, trademarks, copyrights, licenses and trade secret law
to establish and preserve our intellectual property rights. We own a number of
U.S. patents covering certain aspects of our network security product designs,
and have additional U.S. patent applications pending. From time to time we
evaluate the applicability of our patents to other products of third parties. We
also seek to protect our proprietary rights through a combination of employee
and third party nondisclosure agreements.
Research and Development
The market for our products is characterized by rapidly changing
technologies, extensive research and new product introductions. We believe that
our future success will depend in part upon our ability to continue to enhance
our existing products and to develop, manufacture and market new products. As a
result, we expect to continue to make a significant investment in engineering
and research and development. In 1999, 2000 and 2001 we incurred $17.7 million,
$22.2 million, and $17.3 million, respectively, for research and development.
Competition
We compete in the market for network security solutions based on our
portfolio of products and services, their ease of deployment within customers'
existing networks, the reliability of encryption hardware to protect data
communications and our software management platform for our network
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security appliances. We believe that our offering of network appliances and
software solutions is the optimum selection for customers who are seeking to
expand their e-businesses with various network services. We also believe that
our cryptography-based products offer a more flexible and, easily managed
solution for our customers' networks than other vendors' security solutions.
Our competitors in the network security market, including companies that
offer products similar to or perceived as an alternative to our products,
include Checkpoint Software Technologies, Ltd., Network Associates, Inc., RSA
Security, Inc., SafeNet, Inc., Secure Computing Corporation, Symantec
Corporation, and Thales, Inc. Our NetHawk VPN appliance competes with numerous
other products, including those offered or under development by Cisco Systems,
Inc., Newbridge Networks Corporation, Netscreen Technologies, Inc., Sonic Wall,
Inc., and Nokia Corp. A number of significant vendors, including Microsoft,
America On Line and Cisco Systems, have embedded security solutions in their
software.
The Divestiture of Algorithmic Research, Ltd. ("ARL")
On June 22, 2001, the Company announced that it would close or sell its
wholly owned Israeli subsidiary, ARL. On August 9, 2001, Cylink executed an
Allotment and Conversion Agreement and various related documents (collectively
the "ARL Divestiture"), under which Cylink transferred majority ownership in ARL
to ARL's existing employees, and converted its remaining minority interest and
its intercompany debt to preferred stock having certain rights and privileges in
the event of ARL's sale or liquidation. As part of the ARL Divestiture, Cylink
retained ownership of ARL's virtual private networking technology, a royalty
free, irrevocable license to ARL's remaining base of existing intellectual
property solely for incorporating into Cylink Products, and a release and waiver
from all of ARL's existing employees. Cylink also agreed to assign certain
contracts to ARL concerning licenses of ARL's products, and to wind up ARL's
subsidiaries' operations in Germany and Singapore. Under the ARL Divestiture,
ARL will retain ownership and responsibility for all of its other assets and
liabilities.
Employees
As of December 31, 2001, we had 213 employees, of whom 65 were primarily
engaged in research and development, 83 in sales, marketing and related customer
support services, 29 in administration and 36 in manufacturing. Of these
employees, approximately 21 were located in Europe and 5 in Asia. None of our
employees is represented by a collective bargaining agreement with respect to
his or her employment by us, nor have we experienced any organized work
stoppage. We consider our relations with our existing employees to be good.
Factors Affecting Stock Price
The market price of our stock may fluctuate substantially over short time
periods due to a number of factors, including factors that could affect our
future financial performance. Our stock price may also be affected by factors
that influence the overall market for stocks, or stocks of high technology
companies in particular.
Environmental Matters
Neither compliance with federal, state and local provisions regulating
discharge of materials into the environment, nor remedial agreements or other
actions relating to the environment, has had, or is expected to have, a material
effect on our capital expenditures, financial condition, results of operations
or competitive position.
RISK FACTORS
Set forth below and elsewhere in this Annual Report, including in Item 7,
Management's Discussion and Analysis, and in other documents we file with the
Securities and Exchange Commission are risks and uncertainties that could cause
actual results to differ materially from the results contemplated by the
forward-looking statements contained in this Annual Report.
7
We have a history of losses, and may not be able to meet our needs for working
capital.
We have incurred significant net losses in 2001 and in prior years. We had
an accumulated deficit of $118.8 million as of December 31, 2001. Although we
plan to operate at cash flow break even for 2002 on an annual basis, we may
experience shortfalls in revenue and continue to incur losses. Our prior losses
may also adversely impact our ability to raise additional capital if required to
sustain our operations.
As of the date of filing of this Annual Report on Form 10K, the Company's
revenue to date for 2002 is significantly below its plan upon which it had
projected a positive operating cashflow for the year. The Company is in the
process of revising its plan and will initiate actions to cut costs in
accordance with its lowered revenue. However, there can be no assurance that the
Company will be able to achieve its revised plan, or our principal sources of
liquidity, which include cash and cash equivalents of $9.6 million as of
December 31, 2001 and prospective borrowing via our working capital loan, will
satisfy our current anticipated working capital and capital expenditure
requirements through at least the next twelve months. The Company's working
capital loan matures in June 2002. Although we renegotiated our credit facility
in order to obtain more favorable covenants, we breached a certain covenant in
February 2002. There is no guarantee that we will meet that covenant in the
future, and there is no guarantee that the loan will be renewed in June 2002. If
we fail to meet our financial covenant or the facility is not renewed, the line
of credit will not be available to fund our operations if it is needed.
In 2001, we began to realize the benefits of the actions taken in the
fourth quarter of 2000, and the second and third quarters of 2001 to reduce
operating costs in our core business. However, there can be no assurance that we
will be able to continue reducing costs at a pace that reflects any further
reduction in revenues, or that we will not need to raise additional capital to
fund operations within this period or that additional financing could be
obtained on acceptable terms, or at all. If additional funds are raised by
issuing equity securities, dilution to shareholders may result. If adequate
funds are not available, we, our business, and the price of our Common Stock
will be adversely affected.
Our quarterly operating results may vary in the future, which could cause our
stock price to drop.
We have historically experienced significant fluctuations in our operating
results on a quarterly basis and could experience such fluctuations in the
future. Our revenues and operating results could be affected by a number of
factors outside of our control, including the following:
* our inability to accurately forecast revenues and respond in a timely
manner to changes in revenue levels;
* the timing of the introduction by us or by our competitors of new or
enhanced products;
* market acceptance of our new products and those of our competitors;
* the timing, cancellation or delay of customer orders, including
cancellation or delay in anticipation of new product introductions or
enhancements;
* changes in our pricing policies or those of our competitors;
* changes in operating costs and expenses, including those resulting from
changes in available production capacity of independent foundries and other
suppliers and the availability of raw materials;
* changes in the revenue mix from products or services sold;
* changes in the percentage of products sold through our direct sales force;
* loss of an important customer;
* failure to grow our customer base in accordance with market expectations;
* customer discounts and credits;
* our limited ability to reduce expenses to offset any unexpected shortfall
in revenue growth or decrease in revenue;
* delays in manufacturing due to shortages in components or unanticipated
revisions in product design;
8
* expenses incurred in seeking to enforce or defend claims with respect to
intellectual property rights;
* changes in the economy that affect the purchasing decisions of our
customers; and
* disruption in our operations caused by reductions in our workforce.
Many of these factors are outside of our control. Unforeseen reductions in
revenue can materially and adversely affect our ability to raise capital or
sustain ongoing operations.
We are currently involved in litigation.
Several securities class action complaints have been filed against us and
certain of our current and former directors and officers in federal courts in
California. These complaints allege, among other things, that our previously
issued financial statements were materially false and misleading and that the
defendants knew or should have known that these financial statements caused our
common stock price to rise artificially and allege violations of Section 10(b)
of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated
thereunder, and Section 20 of the Exchange Act. The securities class action
lawsuits have been ordered consolidated into a single action pending in the
United States District Court for the Northern District of California, captioned
In Re Cylink Securities Litigation, No. C98-4292 (VRW). For more information on
this lawsuit, see Part I, Item 3. "Legal Proceedings." Although we believe we
have meritorious defenses and adequate insurance for the damages claimed in
these actions, it is not feasible to predict or determine the final outcome of
these proceedings, and if the outcome were to be unfavorable and exceed our
applicable insurance, our business, financial condition, cash flows and results
of operations could be materially adversely affected.
Our sales cycles are long and unpredictable, which makes period-to-period
revenues difficult to predict.
Salesof our products generally involve a significant commitment of capital
by customers, with the attendant delays frequently associated with large capital
expenditures. For these and other reasons, the sales cycle associated with our
products is typically lengthy and subject to a number of significant risks over
which we have little or no control. We are often required to ship products
shortly after we receive orders. Consequently, order backlog at the beginning of
any period has, at times in the past, represented only a small portion of that
period's expected revenue. Furthermore, increases in backlog from quarter to
quarter may be due to placement of orders calling for delivery dates extended
over a much longer period of time into future periods. Consequently, our order
backlog becomes more vulnerable to customer cancellations. As a result of these
fluctuations in our sales cycle and order backlog, product revenue in any period
has been and will continue to be substantially dependent on orders booked and
shipped in that period. We typically plan our production and inventory levels
based on internal forecasts of customer demand, which are highly unpredictable
and can fluctuate substantially. In particular, market forces beyond our
control, including recession, and limits or changes in government spending may
have a material affect on customer demand for our products. If revenue falls
significantly below anticipated levels, as it has at times in the past, our
financial condition and results of operations would be materially and adversely
affected. In addition, our operating expenses are based on anticipated revenue
levels and a high percentage of our expenses are generally fixed in the short
term. Based on these factors, a small fluctuation in the timing of sales can
cause operating results to vary significantly from period to period. It is
possible that in the future our operating results will again be below the
expectations of securities analysts and investors. In such an event, or in the
event that adverse conditions prevail or are perceived to prevail generally or
with respect to our business, or the market sector in which we operate, the
price of our Common Stock would likely be adversely affected. These factors make
it difficult to predict our financial performance. As our quarterly results
fluctuate, they may fall below the expectations of public market analysts or
investors. If this occurs, the price of our Common Stock may drop.
The overall economic climate continues to be weak.
Our products typically represent substantial capital commitments by
customers, involving a potentially long sales cycle. As a result, customer
purchase decisions may be significantly affected by a variety
9
of factors including trends in capital spending for communication networks,
market competition, and the availability or announcement of alternative
technologies. Continued recent weakness in general economic conditions has
resulted in many of our customers delaying and/or reducing their capital
spending related to information systems. If the economy continues to be weak,
demand for our products could decrease, resulting in lower revenues and a
decline in the overall rate of our revenue growth.
We are dependent on recently introduced and new network security products.
Our future results of operations will be highly dependent on the
successful marketing and manufacture of the NetHawk product, as well as
successful marketing and manufacture of the Cylink Link Encryptors, PrivaCy
Manager, Cylink ATM, and Cylink Frame Encryptor products. To date, we have made
only limited commercial shipments of our NetHawk product, which began shipping
in mid-year 2000. This product requires additional development work,
enhancement, and testing to achieve widespread commercial success. If this or
other new or recently introduced products have performance, reliability, quality
or other shortcomings, such products could fail to achieve adequate market
acceptance. The failure of our new or existing products to achieve or enjoy
market acceptance, whether for these or other reasons, could cause us to
experience reduced orders, higher manufacturing costs, delays in collecting
accounts receivable and additional warranty and service expenses, which in each
case could have a material adverse effect on our business, financial condition
and results of operations.
Due to insufficient market acceptance of stand alone public key
infrastructure ("PKI") products, such as our Net Authority and similar products
of our competitors, we revised our marketing approach in the second half of 2001
by discontinuing efforts to sell Net Authority as a stand alone product and
focused our efforts on potential customers seeking to embed our PKI as part of
their application or service. In addition, on February 8, 2002, we received
notice from the United States Postal Service ("USPS") that it was terminating
its license to Cylink's Net Authority product as of March 17, 2002, noting that
its decision was "not a reflection of the quality of work performance provided
by Cylink" but was due to "USPS' immediate need to reduce cost" and downsize its
non core businesses following the anthrax attack on its operations in October of
2001. We recently granted a continuation of USPS' license, at its request,
through May 30, 2002, but we expect this license and all further revenue earned
under Cylink's contract with the USPS to expire in the second quarter of 2002.
Although we continue to explore alternative sources of funding for our PKI
development activity with other potential OEM customers, any effort to continue
development and marketing of Cylink's PKI technology may fail to generate
sufficient revenue to cover its costs if we continue in this business for the
balance of 2002.
We face significant competition from other providers of network security
systems
Competition is intense among providers of network security systems, and we
expect such competition to increase in the future. Significant competitive
factors in these markets include:
* the development of new products and features;
* product quality and performance;
* customer perception regarding the adequacy of security provided by existing
software and routers;
* adoption of embedded security solutions in other vendors' hardware and
software products;
* the quality and experience of our sales, marketing and service
organizations;
* product price;
* name recognition; and
* perception of our stability and long-term viability.
Many of these competitive factors are beyond our control.
Our competitors in the information security markets, including companies
that offer products similar to, or are perceived as an alternative to, our
products, are Checkpoint Software Technologies, Ltd., Network Associates, Inc.,
SafeNet, Inc., Secure Computing Corporation, RSA Security, Inc., Symantec
10
Corporation and Thales e-Security, Inc. Our NetHawk VPN appliance competes with
numerous other products, including those offered or under development by Cisco
Systems, Inc., Newbridge Networks Corporation, Netscreen Technologies, Inc.,
Nokia Corp, and Sonic Wall, Inc. A number of significant vendors, including
Microsoft Corporation, and Cisco Systems, Inc. have embedded security solutions
in their software. To the extent that these embedded or optional security
capabilities provide all or a portion of the functionality provided by our
products, our products may no longer be required by customers to attain network
security.
Many of our competitors have substantially greater financial, technical,
marketing, distribution and other resources, greater name recognition and longer
standing relationships with customers than we possess. Competitors with greater
financial resources are better able to engage in more aggressive marketing
campaigns and sustained price reductions in order to gain market share. Any
period of sustained price reductions would have a material adverse effect on our
financial condition and results of operations. We may not be able to compete
successfully in the future and competitive pressures may result in price
reductions, loss of market share or otherwise have a material adverse effect on
our financial condition and results of operations.
We face the risks from tort and warranty claims that may be made against us.
We face the risks from tort and warranty claims that may be made against
us. Customers rely on our network security products to prevent unauthorized
access to their networks and data transmissions. A malfunction or the inadequate
design of our products could result in tort or warranty claims. A breach of a
customer's network by an unauthorized party, which is attributable to an alleged
defect in our products, may cause substantial damages due to loss or compromise
of the customer's valuable information. Furthermore, there is inadequate legal
precedent for allocating responsibility for such losses caused by the wrongful
acts of third parties. Although we attempt to reduce the risk of such losses
through warranty disclaimers and liability limitation clauses in our sales and
license agreements and by maintaining product liability insurance, there can be
no assurance that such measures will be effective in limiting our liability for
any such damages. Any liability for damages resulting from security breaches or
other product defects could be substantial and could have a material adverse
effect on our business, financial condition and results of operations.
In addition, a well-publicized actual or perceived security breach could
adversely affect the market's perception of security products in general, or our
products in particular, regardless of whether such breach is attributable to our
products. This could result in a decline in demand for our products, which would
have a material adverse effect on our business, financial condition and results
of operations.
On August 2, 2001, Cylink determined that a hardware design could cause a
premature failure of its the backup battery on its Cylink Frame Encryptor (CFE)
product. Shortly thereafter, Cylink announced a program to give its customers
the option of updating their CFE units by returning them to the factory, or
receiving an extended warranty covering the battery through the end of December
2002. Cylink accrued approximately $1.0 million in warranty costs during the
second quarter of 2001 associated with this program. While we believe this
reserve was based on reasonable estimates based on information available to us
at the time, actual costs could exceed these reserves. Since announcing this
program, two of our major customers stated their intention to submit substantial
claims related to their costs of avoiding product failures. Although we believe
such claims may be barred or significantly reduced by the limitations and
exclusions in the governing contracts of sale, there can be no assurance that we
will be found free from liability and any obligation to reimburse customers may
have a material effect on our operations.
We may be unable to retain our executive officers and key personnel that are
critical to our business.
Our future success will depend in large part on the abilities of our
executive officers, key management and technical personnel and our ability to
retain qualified and competent individuals following our reductions in the
employee workforce. There is no guarantee that our present executive management
and technical staff will remain with the Company, particularly if our
performance is not up to expectations,
11
and particularly if general economic recovery leads to expanded alternative
opportunities for such employees. The loss of the services of one or more of our
executive officers or key personnel, or the inability to attract and retain
additional executives and other qualified personnel, could delay product
development cycles or otherwise have a material adverse effect on our business
and operating results.
We may not be able to hire and retain sufficient technical, marketing and
management personnel that we need to succeed because these people are limited in
number and are in high demand.
We may not be able to hire and retain sufficient technical, marketing and
management personnel that we need to succeed because we have limited resources
to expand our work force. We recently experienced, and may continue to
experience, substantial fluctuations in the number of employees and the scope of
our operations in the network security business, resulting in increased
responsibilities for management. To manage our business effectively, we will
need to continue to improve our operational, financial and management
information systems and to retain, motivate and manage our employees. In the
recent past, competition has been intense for qualified technical, marketing and
management personnel. Furthermore, the recent reductions in our workforce, and
fluctuation in our stock price, may create greater uncertainty amongst our
existing employees, who may decide not to continue employment with the Company.
There can be no assurance that we will be able effectively to achieve or manage
any future growth, and our failure to do so could delay product development
cycles or otherwise have a material adverse effect on our financial condition
and results of operations.
Any inability to protect our intellectual property could reduce our competitive
advantage, divert management attention, and require additional intellectual
property to be developed or cause us to incur expenses to enforce our rights.
We rely on patents, trademarks, copyrights, licenses and trade secret law
to establish and preserve our intellectual property rights. We own a number of
U.S. patents covering certain features of our network security product designs,
and have additional U.S. patent applications pending. There can be no assurance
that any patent, trademark, copyright or license owned or held by us will not be
invalidated, circumvented or challenged, that the rights granted thereunder will
provide competitive advantages to us or that any of our pending or future patent
applications will be issued with the scope of the claims sought by us, if at
all. Further, there can be no assurance that others will not develop
technologies that are similar or superior to our technology, duplicate our
technology, misappropriate our trade secrets, or design around the patents owned
by us. Resorting to the courts to protect our intellectual property would
require significant financial and management resources. In addition, the laws of
certain countries in which our products are or may be developed, manufactured or
sold may not protect our products and intellectual property rights to the same
extent as the laws of the United States. Our inability to protect our
intellectual property adequately could have a material adverse effect on our
financial condition and results of operations.
The computer, communications, software and network security industries are
characterized by substantial litigation regarding patent and other intellectual
property rights. In the past, we have received communications from third parties
asserting that our patents, features or content of certain of our products
infringe upon the intellectual property rights held by third parties, and we may
receive such communications in the future. There can be no assurance that third
parties will not assert claims against us that result in litigation. Any
litigation, whether or not determined in our favor, could result in significant
expense to us and could divert management and other resources. In the event of
an adverse ruling in any litigation involving intellectual property, we might be
required to discontinue the use of certain processes, cease the manufacture, use
and sale of infringing products, expend significant resources to develop
non-infringing technology or obtain licenses to the infringing technology and we
may suffer significant monetary damages, which could include treble damages.
There can be no assurance that under such circumstances a license would be
available to us on reasonable terms or at all. In the event of a successful
claim against us and our failure to develop or license a substitute technology
on commercially reasonable terms, our financial condition and results of
operations would be adversely affected. There can be no assurance that existing
claims or any other assertions (or claims for indemnity from customers resulting
from infringement claims) will not materially and adversely affect our financial
condition and results of operations.
12
If we are unable to adapt our services to rapidly changing technology, or if the
market for our network security products fails to grow, our business and
operating results could suffer.
The market for our network security products is characterized by rapidly
changing technology, emerging industry standards, new product introductions and
changes in customer requirements and preferences. Our future success will depend
in part upon end users' demand for network security products in general, and
upon our ability to enhance our existing products and to develop and introduce
new products and technologies that meet customer requirements. We face
continuing challenges to educate customers as to the value of our security
products. We believe that many potential customers do not appreciate the need
for our security products unless and until they have faced a major security
breach. Many potential customers prefer not to disclose significant security
breaches of their networks or are reluctant to invest in the development of a
professional security architecture to protect their networks. This market
resistance is compounded by our limited resources to invest in marketing
campaigns for our products and services.
If we are unable successfully to educate potential customers as to the
value of, and thereby obtain broad market acceptance for, our products and
services, we will continue to rely primarily on selling new and existing
products to our base of existing customers, which will significantly limit any
opportunity for growth. In addition, any significant advance in technologies for
attacking cryptographic systems could render some or all of our existing and new
products obsolete or unmarketable. To the extent that a specific method other
than ours is adopted as the standard for implementing network security in any
segment of the network security market, sales of our existing and planned
products in that market segment may be adversely impacted, which could have a
material adverse effect on our business, financial condition and results of
operations. The National Institute of Standards and Technology has announced
that it will adopt a new Advanced Encryption Standard, or AES, which we expect
to integrate into our products. Our ability to timely implement the AES into our
products may materially affect our development costs and ability to timely
market our solutions. Network security-related products or technologies
developed by others may adversely affect our competitive position or render our
products or technologies noncompetitive or obsolete.
In addition, a portion of the sales of our network security products will
depend upon a robust industry and infrastructure for providing access to public
switched networks, such as the Internet. The infrastructure or complementary
products necessary to turn these networks into viable commercial marketplaces
may not be fully developed, and once developed, these networks may not become
viable commercial marketplaces.
If our research and development activities are unsuccessful, we will not be able
to market new products and services and our business operations and financial
results could be harmed.
The markets for our products are characterized by rapidly changing
technologies, extensive research and new product introductions. We believe that
our future success will depend in part upon our ability to continue to enhance
our existing products and to develop, manufacture and market new products. As a
result, we expect to continue to make a significant investment in engineering,
research and development. We may not be able to develop and introduce new
products or enhancements to our existing products in a timely manner that
satisfy customer needs, achieve market acceptance or address technological
changes in our target markets. If we fail to develop products and introduce them
successfully and in a timely manner, this could adversely affect our competitive
position, financial condition and results of operations.
We face risks associated with our international operations.
We plan to continue to expand our foreign sales channels and to enter
additional international markets, both of which will require significant
management attention and financial resources. International sales are subject to
a number of risks, including unexpected changes in regulatory requirements,
export control laws, tariffs and other trade barriers, political and economic
instability in foreign markets, difficulties in the staffing, management and
integration of foreign operations, longer payment cycles, greater difficulty in
collecting accounts receivable, currency fluctuations and potentially adverse
tax consequences. Since most of our foreign sales are denominated in U.S.
dollars, our products become less
13
price competitive in countries in which local currencies decline in value
relative to the U.S. dollar. The uncertainties of monetary exchange values have
caused, and may in the future cause, some foreign customers to delay new orders
or delay payment for existing orders. The long-term impact of such devaluation,
including any possible effect on the business outlook in other developing
countries, cannot be predicted.
Our ability to compete successfully in foreign countries is dependent in
part on our ability to obtain and retain reliable and experienced in-country
distributors and other strategic partners. We do not have long-term contracts
with most of our value added resellers and distributors and, therefore, have no
assurance of a continuing relationship within a given market.
Due to U.S. government regulations restricting the export of cryptographic
devices and software, including our network security products to non-civilian
agencies of foreign governments, we are often at a disadvantage in competing for
international sales compared to companies located outside the United States that
are not subject to such restrictions. Furthermore, in certain foreign countries,
our distributors are required to secure licenses or formal permission before
encryption products can be imported. Although the Department of Commerce
continues to relax the export control laws as they apply to sales of our
products to our commercial customers, we still face export controls on sales to
certain foreign governments and transfers of our technology to foreign partners.
To date, we have been able to secure the necessary export and import licenses to
compete effectively in the international market. However, we may not be able to
secure such licenses in a timely manner in the future, or at all.
We may incur additional claims arising from the Algorithmic Research Limited
("ARL") Divestiture.
Under the terms of the ARL Divestiture, ARL assumes liability for all of
the tax consequences of the divestiture, the forgiveness of debt, and for the
sale and licenses of ARL's intellectual property. ARL also retains liability for
its contractual obligations, including those arising under certain contracts
assigned to ARL. Although Cylink is indemnified by ARL under the ARL Divestiture
from such obligations, third parties may seek to hold Cylink liable, instead of
or in addition to ARL, for ARL's legal obligations that arose or were incurred
prior to Cylink's divestiture of its wholly owned interest in ARL.
We face risks from our dependence on third party subcontractors and suppliers.
Our ability to deliver our products in a timely manner is dependent upon
the availability of quality components and subsystems used in these products. We
depend in part upon subcontractors to manufacture, assemble and deliver certain
items in a timely and satisfactory manner. We obtain certain components and
subsystems from a single, or a limited number of, sources. A significant delay
in obtaining a source of supply for components selected by our design engineers
or interruption in the delivery of such items could have a material adverse
effect on our financial condition and results of operations.
On February 14, 2002, we notified our OEM supplier of our ISDN encryption
products, Biodata Information Technology AG ("Biodata") of our decision to
terminate our development and supply agreement following Biodata's declaration
of insolvency. Due to Biodata's financial failure, and that of the previous
supplier of our ISDN encryption products, Dica, in the first half of 2001, we
have discontinued all further sales and support for this product line. Although
we attempted to disclaim all liability for Biodata and Dica's failure in our
supply contract with our principal customer for ISDN encryption products, there
can be no assurance that the suppliers' failure, and our discontinuance of this
ISDN product line, will not cause claims for breach of warranty and support by
our customer and end users.
Cylink Common Stock could be delisted from the NASDAQ National Market, which
could adversely affect Cylink and its shareholders.
On July 25, 2001, the Company received a notice from the staff of the
Nasdaq National Market that its Common Stock had failed to maintain the minimum
bid price of $1.00 over the prior 30 trading days as required for continued
listing on the Nasdaq National Market. The notice stated that if during the 90
days following the date of the notice the bid price of Cylink Common Stock
failed to close at or above $1.00 for at least 10 consecutive trading days, then
Cylink Common Stock could be delisted.
14
On September 27, 2001, NASDAQ suspended its minimum bid price requirements
until January 2002. Since that date, our Common Stock has traded within NASDAQ's
minimum requirements for maintaining our listing on the Nasdaq National Market.
However, there can be no assurance that we will satisfy such requirements in the
future, or that we will be able to preserve our listing on the Nasdaq National
Market. Prior to any actual delisting, we would have an opportunity to request a
hearing to present our plan to comply with the continued listing requirements.
If Cylink Common Stock were to be delisted from the Nasdaq National Market,
we could apply for listing on the Nasdaq SmallCap Market, the OTC Bulletin Board
or another quotation system or exchange for which we could qualify. We cannot
guarantee, however, that we could apply for listing on another quotation system
or exchange if we are delisted from the Nasdaq National Market or that if we do
apply for listing that we will be eligible initially for such listing or that if
we do become listed, that we will be able to maintain eligibility. Listing on
another quotation system or exchange may negatively affect the price of our
Common Stock because stocks trading on over-the-counter markets are typically
less liquid and trade with larger variations between the bid and ask prices. In
addition, the delisting of our Common Stock from the Nasdaq National Market
would adversely affect or limit or restrict our ability to raise funds through
stock issuances.
If the market price for our Common Stock were to fall below $1.00 per share
such that we were no longer listed on the Nasdaq National Market, our Common
Stock could be deemed to be penny stock. If our Common Stock were considered
penny stock, it would be subject to rules that impose additional sales practices
on broker-dealers who sell our securities. For example, broker-dealers must make
a special suitability determination for the purchaser and have received the
purchaser's written consent to the transaction prior to sale. Also, a disclosure
schedule must be prepared prior to any transaction involving a penny stock and
disclosure is required about sales commissions payable to both the broker-dealer
and the registered representative and current quotations for the securities.
Monthly statements are also required to be sent disclosing recent price
information for the penny stock held in the account and information on the
limited market in penny stock. Because of these additional obligations, some
brokers may be unwilling to effect transactions in penny stocks. This could have
an adverse effect on the liquidity of our Common Stock under those
circumstances.
Terrorist attacks may negatively impact all aspects of our operations, revenues,
costs and stock price.
Recent terrorist attacks in the United States, as well as future events
occurring in response or connection to them, including, without limitation,
future terrorist attacks against United States targets, rumors or threats of
war, actual conflicts involving the United States or its allies or military or
trade disruptions impacting our domestic or foreign suppliers of merchandise,
may impact our operations, including, among other things, causing delays or
losses in the delivery of goods and supplies to us and decreased sales of the
products we carry. More generally, any of these events may have affected, and
may continue to affect, the general economy and customers' demand for capital
equipment. Any of these occurrences could have a significant impact on our
operating results, revenues and costs, may result in the volatility of the
market price for our Common Stock, and have an adverse impact on the future
price of our Common Stock.
Recent Accounting Pronouncements May Impact Our Financial Position and Results
of Operations.
We must adopt the recent changes in financial accounting standards. In June
2001, the Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other
Intangible Assets". The valuation of the Company's goodwill and intangible
assets under SFAS 142 depends on certain factors outside of our control,
including our stock price, and we may be required to write down some or all of
the $16.6M net carrying value of our investment in intangibles reported as of
December 31, 2001. Any determination under SFAS 142 of an impairment of our
investment in intangibles could have a material impact on Cylink's financial
position and results of operations.
15
In June, July and August 2001, the FASB also issued SFAS 141 "Business
Combinations", SFAS 143, "Accounting for Asset Retirement Obligations", and SFAS
144, "Impairment or Disposal of Long-Lived Assets", respectively, which are
effective for fiscal years beginning after December 15, 2001. We are currently
assessing the impact of these new standards, and as such, it is possible that
the adoption of one or more of thse SFAS' could have a material effect on its
financial condition or results of operations. For a further discussion of how
these recent accounting pronouncements may affect us, please see Item 7,
Management's Discussion and Analysis and the Notes to the Consolidated Financial
Statements. There can be no assurances that the issuance by FASB of additional
statements of financial accounting standards would not materially adversely
affect our business, financial condition, and results of operations if such are
required to be adopted by us in the future.
ITEM 2. PROPERTIES
Our headquarters occupy 118,000 square feet in Santa Clara, California, the
lease for which expires in August 2009. Of this total, 22,000 square feet is
currently subleased to other outside subtenants. We plan to sublease an
additional 24,500 square feet which exceeds our current and planned future
requirements for a period of approximately three years. As a result of the
acquisition of Celotek in fiscal 2000, we hold the lease to the Cylink ATM
Center, comprising approximately 10,000 square feet in Raleigh, North Carolina,
which expires in June 2003. We also lease facilities for sales offices in New
Jersey, Virginia, North Carolina, Belgium, the United Kingdom and Singapore. We
believe that our current facilities are well maintained and are adequate for the
foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
Securities Class Action.
In 1998, we filed amended Forms 10-Q for the first and second quarters of
1998 and an amended Form 10K for 1997, reflecting restated financial results for
those quarters, and for the fourth quarter of 1997. Between November 6, 1998 and
December 14, 1998, several securities class action complaints were filed against
us and certain of our current and former directors and officers in federal
courts in California. These complaints allege, among other things, that our
previously issued financial statements were materially false and misleading and
that the defendants knew or should have known that these financial statements
caused our common stock price to rise artificially. The actions variously allege
violations of Section 10(b) of the Securities Exchange Act of 1934 (the
"Exchange Act"), as amended, and SEC Rule 10b-5 promulgated thereunder, and
Section 20 of the Exchange Act.
The securities class action lawsuits have been ordered consolidated into a
single action pending in the United States District Court for the Northern
District of California, captioned In Re Cylink Securities Litigation, No.
C98-4292 (VRW). The action is currently pending before the Court.
We believe we have meritorious defenses and adequate insurance for the
damages claimed in these actions and we intend to defend the Company vigorously.
However, it is not feasible to predict or determine the final outcome of these
proceedings, and if the outcome were to be unfavorable and exceed our applicable
insurance, our business, financial condition, cash flows and results of
operations could be materially adversely affected.
Other Litigation
In addition, in the normal course of business, we, from time to time,
receive inquiries or other communication with regard to possible infringement of
third party intellectual property rights by our patents, or the features or
content of certain of our products. We believe it is unlikely that the outcome
of these infringement inquiries will have a material adverse effect on our
financial position or results of operations, however if litigation results from
any of these inquires and the outcome is unfavorable to us, it could have a
material adverse effect on our cash flows, results of operations and financial
condition.
There has been substantial litigation regarding patent and other
intellectual property rights in the software and network security related
industries. Further commercialization of our products could provoke claims of
infringement from third parties. In the future, litigation may be necessary to
enforce our
16
patents, to protect our trade secrets or know-how or to defend against claimed
infringement of the rights of others and to determine the scope and validity of
the proprietary rights of others. Any such litigation could result in
substantial cost and diversion of our efforts, which by itself could have a
material adverse effect on our financial condition and operating results.
Further, adverse determinations in such litigation could result in loss of
proprietary rights, subject us to significant liabilities to third parties,
require us to seek licenses from third parties or prevent us from manufacturing
or selling our products, any of which could have a material adverse effect on
our business, financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders, through
solicitation of proxies or otherwise, during the fourth quarter of the fiscal
year covered by this report.
17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS
Our Common Stock has been traded in the over-the-counter market under the
symbol CYLK since our initial public offering on February 15, 1996. The
following table sets forth the high and low closing prices as reported on the
Nasdaq National Market during the last two years:
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ----------
Year Ended December 31, 2001
High .................... $ 4.69 $ 2.00 $ 1.76 $ 3.75
Low ..................... $ 1.63 $ 0.54 $ 0.37 $ 0.75
Year Ended December 31, 2000
High .................... $ 22.75 $ 19.94 $ 19.38 $ 11.44
Low ..................... $ 10.88 $ 8.81 $ 8.75 $ 1.56
As of March 15, 2002, we had approximately 450 shareholders of record and
7,300 beneficial owners. We have never declared or paid dividends on our capital
stock. We currently intend to reinvest any earnings in the development of our
business and do not intend to pay dividends in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial information has been derived from our
audited consolidated financial statements. The information set forth below is
not necessarily indicative of results of future operations and is qualified by
reference to and should be read in conjunction with the consolidated financial
statements and related notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations included elsewhere in this Annual
Report.
Year ended December 31,
------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------ ------------ ------------ ------------ ------------
(in thousands, except per share amounts)
Revenue ........................... 48,566 $ 68,107 $ 59,655 $ 42,760 $ 47,690
Gross profit ...................... 29,929 40,866 40,496 25,862 33,704
Total operating expenses .......... 51,645 76,925 59,289 54,720 101,673
Loss from continuing operations ... (20,050) (35,388) (16,877) (17,356) (64,955)
Loss from continuing operations per
share -- basic and diluted ....... $ (0.62) $ (1.15) $ (0.58) $ (0.60) $ (2.43)
Year ended December 31,
------------------------------------------------------------
2001 2000 1999 1998 1997
-------- ---------- ---------- ---------- ----------
(in thousands)
Cash, cash equivalents and short-
term investments ........................ 9,606 $15,250 $33,170 $46,575 $22,977
Working capital .......................... 15,739 25,138 43,243 60,587 47,985
Total assets ............................. 52,692 78,884 81,289 94,318 76,555
Capital lease and long term debt ......... 1,927 1,454 112 147 256
Shareholders' equity ..................... 39,888 59,153 61,979 75,221 66,134
On March 28, 1998, we sold our Wireless Communications Group (the "Wireless
Group"), which has been reported as discontinued operations and, therefore, the
above consolidated statements of operations information excludes discontinued
operations for all periods presented.
The net loss for 1997 included a charge of approximately $63.9 million
($2.39 per share) for purchased in-process technology resulting from the
acquisition of ARL. The results of operations of ARL are included until its
divestiture in August 2001.
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
We develop, market and support a comprehensive portfolio of hardware and
software security products for mission-critical private networks and business
communications over the Internet. The following discussion regarding the
Company's financial condition and results of operations should be read in
conjunction with the Consolidated Financial Statements and Notes thereto.
Critical Accounting Policies and Estimates
Cylink's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires
Cylink to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an ongoing basis, Cylink evaluates its estimates,
including those related to allowance for doubtful accounts, inventories,
investments, deferred tax assets, intangible assets, income taxes, warranty
obligations, restructuring, and contingencies and litigation. Cylink bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
Cylink believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements:
Revenue Recognition. Our revenue recognition policy is significant because
our revenue is a key component of our results of operations. In addition, our
revenue recognition determines the timing of certain expenses, such as sales and
distributor commissions. We follow very specific and detailed guidelines in
measuring revenue, which are outlined in Note 1 to the Consolidated Financial
Statements, and all material contracts are routinely reviewed for compliance
with revenue recognition criteria. However, certain judgments affect the
application of our revenue policy. Revenue results are difficult to predict, and
any shortfall in revenue or delay in recognizing revenue could cause our
operating results to vary significantly from quarter to quarter and could result
in future operating losses.
Accounts Receivable Reserves. We record a provision for estimated sales
returns and allowances in the same period as the related revenues are recorded.
These estimates are based on historical sales returns, analysis of credit memo
data and other known factors. If the historical data the Company uses to
calculate these estimates does not properly reflect future sales returns,
revenue could be overstated. We maintain allowances for doubtful accounts for
estimated losses resulting from the inability of our customers to make required
payments. We provide an allowance for doubtful accounts for all specific
receivables that we judge to be unlikely to be collected. In addition, we record
a reserve based on the size and age of all receivable balances against which we
have not established specific reserves. These estimated allowances are
periodically reviewed, analyzing the customer's payment history and information
regarding customer's credit worthiness known to us. If the financial condition
of our customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required.
Inventory Write-Down. We write-down inventory cost to reflect slow-moving
and obsolete inventory based on current assessments about future demands,
historical trends, and marketing initiatives to end-of-life certain product
lines. If market conditions are less favorable than our assessments, additional
inventory write-downs may be required.
Warranty Reserves. We provide for the estimated cost of product warranties
at the time revenue is recognized. While we engage in extensive product quality
programs and processes, including actively monitoring and evaluating the quality
of our component suppliers, our warranty obligation is affected by product
failure rates, material usage and service delivery costs incurred in correcting
a product failure. Should actual product failure rates, material usage or
service delivery costs differ from our estimates, revisions to the estimated
warranty liability may be required.
19
Restructuring Charges. We recorded a $1.4 million charge to cover the
estimated costs of excess leased facilities and related furniture and equipment,
net of estimated proceeds from planned subleasing of excess office space. These
charges are predicated on our assumptions regarding the prevailing market for
sublease rental rates, the term of a sublease, and the time necessary to market
the unoccupied space. Actual market conditions or updated assumptions based on
future market conditions could cause additional restructuring charges in future
quarters.
Recently issued accounting standards
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations". In August 2001, the FASB issued SFAS 144, "Impairment or Disposal
of Long-Lived Assets", which is effective for fiscal years beginning after
December 15, 2001. We do not expect the adoption of SFAS 141 or the adoption of
SFAS 144 to have a material effect on our financial condition or results of
operations.
In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible
Assets". SFAS 142 requires that goodwill be tested for impairment at least
annually at the reporting unit level. The carrying value of a reporting unit
must be compared to the fair value of that reporting unit to assess whether an
impairment of value has occurred. The fair value may be dependent on the future
valuation of the Company's stock, projected future cashflows of the business,
and other factors that might affect the independent valuation of the Company.
Cylink is required to complete the transitional goodwill impairment test by
June 30, 2002 and is not able to predict at this time whether the determination
of fair value under this statement will result in an impairment of goodwill.
Given $16.6 million net carrying value of its investment to intangibles at
December 31, 2001, an impairment determination could have a material impact on
Cylink's financial position and results of operations.
In July 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement
Obligations". We have not assessed the impact of this new standard, and as such,
it is possible that its adoption could have a material effect on its financial
condition or results of operations.
Results of Continuing Operations
We have incurred significant net losses in 2001 and in prior years. The
Company had an accumulated deficit of $118.8 million as of December 31, 2001.
Although we plan to operate at cash flow break even for 2002 on an annual basis,
we may experience shortfalls in revenue and continue to incur losses. Our prior
losses may also adversely impact our ability to raise additional capital if
required to sustain our operations.
The Company believes that its principal sources of liquidity, which include
cash and cash equivalents of $9.6 million as of December 31, 2001 and
prospective borrowing via the Company's working capital loan, will satisfy the
Company's current anticipated working capital and capital expenditure
requirements through at least the next twelve months. The Company's working
capital loan matures in June 2002 and provides for up to $7.5 million of
borrowings, depending on the amount of eligible accounts receivable, as defined
in the agreement. The Company has renegotiated its credit facility in order to
obtain more favorable covenants. There is no guarantee, however, that the
Company can continue to meet those covenants, and there is no guarantee that the
loan will be renewed in June 2002. If the Company fails to do either, the line
of credit will not be available to fund our operations if it is needed.
Throughout 2001, the Company began to realize the benefits of the actions
taken in the fourth quarter of 2000, and the second and third quarters of 2001
to reduce operating costs in its core business, and believes such cost
reductions are sustainable for the rest of 2002. However, there can be no
assurance that the Company will be able to continue reducing costs at a pace
that reflects any further reduction in revenues, and no assurance that the
Company will not need to raise additional capital to fund operations within this
period. There can be no assurance that additional financing can be obtained on
acceptable terms, or at all. If additional funds are raised by issuing equity
securities, dilution to shareholders may result. If adequate funds are not
available, the Company, its business, and the price of our Common Stock will be
adversely affected.
20
Except where noted, the comments herein are associated with the results of
our continuing operations. The following table sets forth certain consolidated
statement of operations data as a percentage of revenue for the periods
indicated:
Year ended December 31,
---------------------------------------
2001 2000 1999
----------- ----------- -----------
Revenue ...................................................... 100.0% 100.0% 100.0%
Cost of revenue .............................................. 38.4 40.0 32.1
----- ----- -----
Gross profit ................................................. 61.6 60.0 67.9
Operating expenses:
Research and development, net ............................... 34.9 32.3 27.1
Selling and marketing ....................................... 33.5 49.4 44.1
General and administrative .................................. 21.7 20.0 23.5
Amortization of purchased intangibles ....................... 6.6 4.6 4.7
Loss from divestiture of Algorithmic Research, Ltd. ......... 5.5 -- --
Restructuring Charges ....................................... 4.1 1.2 --
Purchased in-process technology ............................. -- 5.4 --
----- ----- -----
Total operating expenses .................................. 106.3 112.9 99.4
----- ----- -----
Loss from operations ...................................... (44.7) (52.9) (31.5)
Other income, net ......................................... 1.1 1.6 3.5
----- ----- -----
Loss from continuing operations before income taxes .......... (43.6) (51.3) (28.0)
Income tax expense (benefit) ................................. ( 2.3) 0.6 0.3
----- ----- -----
Loss from continuing operations .............................. (41.3)% (51.9)% (28.3)%
===== ===== =====
Revenue. Revenue was $48.6 million, $68.1 million and $59.7 million for the
years ended December 31, 2001, December 31, 2000 and December 31, 1999,
respectively. This represents a 29% decrease for the year ended December 31,
2001 from the year ended December 31, 2000. The decrease in 2001 was due
primarily to lower unit volumes resulting from a market slowdown and the
divestiture of ARL.
Revenues increased 14% from $59.7 million for the year ended December 31,
1999 to $68.1 million for the year ended December 31, 2000. The increase in 2000
was attributable to new revenue streams contribute by new product releases for
the NetAuthority Public Key Infrastructure software product, the NetHawk VPN
Encryptors, and the ISDN Encryptors. In addition, revenue growth in 2000 was
also due to increases in unit shipments of existing products, shipments of
products with higher average selling prices, and increased revenues associated
with software maintenance and support services.
International product revenue was 37%, 39%, and 44% of revenue for 2001,
2000, and 1999, respectively.
Gross Profit. Gross profit decreased 27% from $40.9 million in 2000 to
$29.9 million in 2001, but increased as a percentage of sales from 60% to 62%.
The dollar decrease was due to decreased revenues. The increase in gross profit
as a percentage of revenue in 2001 resulted from product margin improvements in
our ATM encryptor product resulting from our acquisition of Celotek corporation,
disposition of lower margin professional services and ARL subsidiaries, offset
by higher provisions for inventory write-downs related to discontinued products
and additional warranty reserves for Cylink's CFE product.
Gross profit increased 1% from $40.5 million in 1999 to $40.9 million in
2000, and decreased as a percentage of sales from 68% to 60%. The dollar
increase was due to increased revenues. The decrease in gross profit as a
percentage of revenue resulted from inventory valuation adjustments related to
discontinued products and overhead cost adjustments in addition to a shift in
product mix towards lower margin OEM products.
Research and Development. Research and development expenses consist
primarily of salaries and other personnel-related expenses, depreciation of
development equipment, facilities costs and supplies. Gross research and
development expenses decreased 23% from $22.2 million in 2000 to $17.1 million
in
21
2001 and increased 25% from $17.7 million in 1999. The increase in expenses as a
percent of sales for 2001 as compared to 2000 resulted from a greater reduction
in revenues than could be realized in reduced project spending and headcount
reductions in the same period. The increase in expenses as a percent of sales
for 2000 as compared to 1999 resulted from increased product development
investments in NetAuthority, our Public Key Infrastructure product, ATM
Encryption technologies, associated with the acquisition of Celotek Corporation
and next generation encryption technologies.
From time to time, we receive engineering funding for development projects
to apply or enhance our technology to a particular customer's need. The amounts
recognized under these research and development contracts are offset against
research and development expense. Amounts that were recognized under
non-recurring engineering contracts were not material in 2001 and 2002, and
totaled $1.5 million in 1999.
Selling and Marketing. Selling and marketing expenses consist primarily of
personnel costs, including sales commissions, and costs of advertising, public
relations, seminars and trade shows. Selling and marketing expenses decreased
52% from $33.7 million in 2000 to $16.3 million in 2001 and increased 28% from
$26.3 million in 1999 to $33.7 million in 2000. The decrease from 2000 to 2001
was the result of lower commission spending caused by decreased revenue, lower
headcount spending due to reduction-in-workforce actions, and lower marketing
and bonus spending due to the implementation of cost savings initiatives. The
increases in 2000 over 1999 were primarily to support the launch of new products
as well as the continued expansion of our direct field operations, product line
management, market development, advertising via the "securing e-business"
campaign, channel and distribution development, and international operations.
General and Administrative. General and administrative expenses consist
primarily of personnel and related costs, recruitment expenses, information
system costs, audit, legal and other professional service fees. General and
administrative expenses decreased 23% from $13.6 million in 2000 to $10.5
million in 2001 and decreased 2% from $14.0 million in 1999 to $13.6 million in
2000. The dollar decrease in 2001 over 2000 resulted from lower headcount
spending driven by reduction-in-workforce actions taken in the fourth quarter of
2000 and during 2001, and lower bonus and other administrative spending due to
cost savings initiatives. The increase as a percentage of revenue in 2001
resulted from a greater reduction in revenues than could be realized in reduced
administrative spending and headcount reductions in the same period. The dollar
decrease in 2000 over 1999 resulted from lower spending related to the
implementation of the Enterprise Resource Planning system, accounting and
consulting expenses from the restatement, and legal fees for litigation defense.
The decrease as a percentage of revenue in 2000 was due to the allocation of
costs over a wider revenue base.
Amortization of Purchased Intangibles. The amortization of intangible
assets, which resulted from the acquisition of ARL in 1997, Security Design
International, or SDI, in 1999, and Celotek Corporation, or Celotek, in 2000
(see Note 4 to the Financial Statements) was $3.2 million, $3.1 million, and
$2.8 million in 2001, 2000, and 1999, respectively. At December 31, 2001,
intangibles are primarily composed of goodwill, developed technology, and other
intangibles acquired in the Celotek acquisition. Upon adoption of SFAS 142 on
January 1, 2002, we discontinued the amortization of goodwill under the terms of
that pronouncement.
Loss from divestiture of Algorithmic Research, Ltd. During 2001, the
Company recorded a charge of $2.7 million representing the write-down of assets
and other losses associated with the divestiture of that subsidiary. (See note 5
to the Consolidated Financial Statements.)
Restructuring Charges. In the fourth quarter of 2001, the Company recorded
a $1.4 million charge to cover the estimated costs of excess leased facilities
and related furniture and equipment, net of estimated proceeds from planned
subleasing of excess office space. In the second, third and fourth quarters of
2001, the Company initiated workforce reductions incurring an additional $0.6
million in severance charges. In the fourth quarter of 2000, the Company
incurred total pre-tax charges of $0.8 million related to the Company's
restructuring and reorganization efforts. The year 2000 actions were designed to
streamline the Company's operations, reduce operating costs, and position the
Company for profitability. The restructuring actions in 2000 included $0.5
million in severance charges related to
22
streamlining the Company's operational, sales, marketing, and administrative
functions, and $0.3 million in building and equipment lease charges related to
the shut down of remote offices. As a result of the fourth quarter 2000
restructuring, approximately 67 positions were eliminated. The restructuring was
completed by the end of the first quarter of 2001.
Purchased In-Process Technology. Approximately $3.7 million of the total
purchase price for the acquisition of Celotek represented the value of
in-process technology that had not yet reached technological feasibility, had no
alternative future uses and was charged to our operations in the third quarter
ended October 1, 2000 (see Note 4 to the Financial Statements).
Other Income (Expense), Net. Other income (expense), net, primarily
consists of royalties, interest income, interest expense and investment gains
and losses. We generated other income of $0.5 million in 2001, $1.1 million in
2000, and $2.1 million in 1999. Other income decreased from $1.1 million in 2000
to $0.5 million in 2001 due to the decrease in average balances of cash, cash
equivalents, and marketable securities resulting from operational losses, and a
write-down of the Company's investment in an unaffiliated company. Other income
decreased from $2.1 million in 1999 to $1.1 million in 2000 due to reduced
interest income on lower average balances of cash, cash equivalents, and
marketable securities resulting from operational losses.
Income Taxes. In 2001, the Company recognized a tax benefit of $1.1 million
representing the partial recognition of the Company's net operating loss for
income tax purposes. In 2000, the Company recognized a $0.4 million provision
for income taxes for continuing operations. No provision or benefit for income
taxes for continuing operations was recorded in 1999. Our effective tax rate for
2001, 2000 and 1999 was approximately (5.6%), 1%, and 1% respectively.
Loss from Continuing Operations. We had losses from continuing operations
of $20.1 million in 2001, $35.4 million in 2000, and $16.9 million in 1999. In
1994, the Company began a strategic research and development program designed to
create new products and enhance existing products, which continued through 2001.
Late in 2000, and continuing through 2001, we recognized an economic market
slowdown impacting our customers' capital spending plans, and took actions aimed
at reducing our workforce to levels consistent with expected revenues, as well
as divested ourselves of unprofitable subsidiaries not supporting our core
encryptor appliance business. In 2000, we incurred an increased net loss due to
lower gross profit margins driven by inventory valuation adjustments related to
discontinued products, a shift in product mix toward lower margin OEM products,
continued high levels of research and development expenses related to our
strategic research and development projects and the acquisition of Celotek
Corporation, high levels of sales and marketing expenses to support the launch
of new products as well as the continued expansion of our direct field
operations, product line management, market development, advertising via the
"securing e-business" campaign, channel and distribution development, and
international operations, amortization related to the acquisition of Algorithmic
Research Ltd ,or ARL, and Celotek, as well as Purchased In-Process Technology
charges partially offset by higher revenues.
Liquidity and Capital Resources
At December 31, 2001, we had working capital of $15.7 million, including
cash and cash equivalents of $9.6 million, representing a 37% decrease versus
working capital balances of $25.1 million in 2000 and a 38% decrease versus cash
and cash equivalent balances of $15.3 million in 2000. These decreases were
largely due to net losses from operations. We have reported net losses from
continuing operations each year since 1994. Net cash used by operating
activities for the years ended December 31, 2001, 2000, and 1999 was $3.7
million, $21.6 million, and $8.4 million, respectively. Net cash used in
operating activities decreased in 2001 from 2000 primarily due to decreased
operating losses from continuing operations and reductions in receivables due to
improved collections and reductions in inventory balances due to better
management as well as the recovery of income tax refunds. Net cash used in
operating activities increased in 2000 from 1999 primarily due to increased
operating losses from continuing operations and increases in inventory to fund
revenue growth, which were partially offset by the recovery of income tax
refunds due to Cylink.
Net cash used in investing activities in 2001 was $2.0 million, resulting
from acquisition of capital equipment totaling $0.7 million, cash transferred in
connection with our divestiture of Algorithmic Research, Ltd totaling $1.9
million, offset in part by a $0.6 million collection of an employee note
receivable.
23
In 2000, net cash used in investing activities was $2.7 million, resulting from
acquisition of property, plant and equipment related to our investment in
leasehold improvements and computer equipment purchases totaling $3.0 million,
the cash portion of our acquisition of Celotek Corporation totaling $1.1
million, offset in part by $1.4 million in collections of employee notes
receivable. Expenditures for property and equipment for all periods presented
have generally consisted of computer workstations, networking equipment, office
furniture and equipment, and leasehold additions and improvements.
Cash provided by financing activities was $0.1 million, $6.3 million, and
$0.8 million for the years ended December 31, 2001, 2000, and 1999,
respectively. For the years ended December 31, 2001, 2000, and 1999, cash
provided by financing activities resulted primarily from the proceeds from the
issuance of Common Stock under our stock option plans and, in 2001 and 2000,
from the issuance of Common Stock under our stock purchase plan.
As of the date of filing of this Annual Report on Form 10K, the Company's
revenue to date for 2002 is significantly below its plan upon which it had
projected a positive operating cashflow for the year. The Company is in the
process of revising its plan and will initiate actions to cut costs in
accordance with its lowered revenue. However, there can be no assurance that the
Company will be able to achieve its revised plan, or that existing cash balances
and available borrowing will be sufficient to fund operations through 2002.
Cylink has a $7.5 million revolving line of credit with its bank subject to
borrowing limits based on the amount of Company's eligible accounts receivable.
The line of credit is intended to assist the Company, if necessary, in meeting
its working capital requirements. The line of credit is subject to the Company's
satisfaction of a certain financial covenant during the term of the loan. The
Company was in compliance with its financial covenant at December 31, 2001, but
breached its covenant in February 2002. There can be no assurances that the
Company will be able to meet its financial covenant in the future. There have
been no advances under the Company's existing line since inception.
In the event the Company's financial plan is unsuccessful, or it is
otherwise unable to satisfy the conditions for use of this revolving line of
credit, the Company may require additional funds in the near term to support
working capital requirements or for other purposes and may seek to raise such
additional funds through public or private equity or debt financing, sales of
assets, or from other sources. No assurance can be given that additional
financing will be available or that, if available, will be on terms favorable to
the Company or its shareholders. If it is unsuccessful in revising its financial
plan, and cannot raise additional funds either through its line of credit or
other sources, the Company may not have the resources to maintain its
operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of December 31, 2001, we held a total of $9.6 million of cash and cash
equivalents. These securities consist primarily of money market funds and
high-grade, short-term corporate obligations. Certain of these securities are
subject to interest rate risk and will decline in value if market interest rates
increase. If market interest rates were to increase immediately and uniformly by
10 % from levels as of December 31, 2001, the decline in fair value of the
portfolio would not be material.
We transact substantially all of our revenues and costs in U.S. dollars and
our results of operations would not be materially affected by fluctuations in
foreign exchange rates. Accordingly, to date, we have not used material amounts
of derivative financial instruments. As of December 31, 2001, we had no fixed
rate obligations except for capitalized leases and long-term debt of
approximately $139,000. As such, the fair value of our fixed rate obligations is
not subject to a material adverse impact from changes in interest rates.
24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements and Financial Statement Schedule
Page
-----
Financial Statements:
Independent Auditors' Report ................................. 26
Consolidated Balance Sheets at December 31, 2001 and 2000 .... 27
Consolidated Statements of Operations for the years ended
December 31, 2001, 2000, and 1999 ......................... 28
Consolidated Statements of Shareholders' Equity and
Comprehensive Loss for the years ended December 31, 2001,
2000, and 1999 ............................................ 29
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000, and 1999 ......................... 30
Notes to Consolidated Financial Statements ................... 31
Financial Statement Schedule:
Schedule II -- Valuation and Qualifying Accounts for the years
ended December 31, 2001, 2000, and 1999 ................... 51
All other schedules are omitted because they are not required, are not
applicable, or the information is included in the consolidated financial
statements or notes thereto.
25
Independent Auditors' Report
To the Board of Directors and Shareholders of Cylink Corporation:
We have audited the accompanying consolidated balance sheets of Cylink
Corporation and subsidiaries ("Company") as of December 31, 2001 and 2000, and
the related consolidated statements of operations, shareholders' equity and
comprehensive loss and of cash flows for each of the three years in the period
ended December 31, 2001. Our audits also included the consolidated financial
statement schedule listed in Item 14(a)2 for each of the three years in the
period ended December 31, 2001. These financial statements and the financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and the
financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company at December 31,
2001 and 2000, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 2001 in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, such consolidated financial statement schedule for the years
ended December 31, 2001 2000, and 1999, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
The accompanying consolidated financial statements for the year ended
December 31, 2001 have been prepared assuming that the Company will continue as
a going concern. As discussed in Note 1 to the financial statements, the
Company's recurring net losses raise substantial doubt about its ability to
continue as a going concern. Management's plans concerning these matters are
also described in Note 1. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ DELOITTE & TOUCHE LLP
Deloitte & Touche LLP
San Jose, California
February 8, 2002
26
Cylink Corporation
Consolidated Balance Sheets
(Dollars in thousands, except share and per share data)
December 31,
--------------------------
2001 2000
------------ -----------
Assets
Current assets:
Cash and cash equivalents ............................................. $ 9,606 $ 15,250
Accounts receivable, net of allowances of $1,057 and $1,499 ........... 10,102 14,927
Inventories ........................................................... 4,832 10,741
Deferred income taxes ................................................. -- 800
Other current assets .................................................. 2,076 1,697
---------- ---------
Total current assets ............................................... 26,616 43,415
Restricted cash .......................................................... 1,400 1,400
Property and equipment, net .............................................. 6,075 10,241
Acquired technology, goodwill and other intangibles ...................... 16,648 20,707
Notes receivable from employees or former employees ...................... 1,021 2,310
Other assets ............................................................. 932 811
---------- ---------
$ 52,692 $ 78,884
========== =========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of lease obligations and equipment line of credit ..... $ 139 $ 288
Accounts payable ...................................................... 2,757 5,137
Accrued liabilities ................................................... 5,439 9,346
Income taxes payable .................................................. 412 359
Deferred revenue ...................................................... 2,130 3,147
---------- ---------
Total current liabilities .......................................... 10,877 18,277
---------- ---------
Capital lease obligations ................................................ -- 86
Deferred revenue and other accruals, less current portion ................ 1,927 1,368
---------- ---------
1,927 1,454
Commitments and contingencies (Notes 14 and 16)
Shareholders' equity:
Preferred stock, $0.01 par value; 5,000,000 shares authorized; none
issued and outstanding -- --
Common stock, $0.01 par value; 55,000,000 shares authorized;
32,872,000 and 32,681,000 shares issued and outstanding .............. 329 327
Additional paid-in capital ............................................ 158,359 158,805
Deferred compensation ................................................. -- (1,231)
Accumulated other comprehensive loss .................................. (18) (16)
Accumulated deficit ................................................... (118,782) (98,732)
---------- ---------
Total shareholders' equity ......................................... 39,888 59,153
---------- ---------
$ 52,692 $ 78,884
========== =========
The accompanying notes are an integral part of these financial statements.
27
Cylink Corporation
Consolidated Statements of Operations
(in thousands, except per share data)
Year ended December 31,
------------------------------------------------
2001 2000 1999
-------------- -------------- --------------
Revenue:
Product Revenue ................................................ $ 37,711 $ 58,539 $ 54,545
Services Revenue ............................................... 10,855 9,568 5,110
---------- ---------- ----------
Total Revenue ............................................... $ 48,566 $ 68,107 $ 59,655
Cost of revenue
Cost of Product Revenue ........................................ 14,739 21,483 15,883
Cost of Services Revenue ....................................... 3,898 5,758 3,276
---------- ---------- ----------
Total Cost of revenue ....................................... 18,637 27,241 19,159
---------- ---------- ----------
Gross profit ...................................................... 29,929 40,866 40,496
---------- ---------- ----------
Operating expenses:
Research and development, net .................................. 16,961 21,994 16,176
Selling and marketing .......................................... 16,288 33,691 26,316
General and administrative ..................................... 10,528 13,626 13,998
Amortization of purchased intangibles .......................... 3,215 3,115 2,799
Loss from divestiture of Algorithmic Research, Ltd. ............ 2,661 -- --
Restructuring charges .......................................... 1,992 818 --
Purchased in-process technology ................................ -- 3,681 --
---------- ---------- ----------
Total operating expenses .................................... 51,645 76,925 59,289
---------- ---------- ----------
Loss from operations .............................................. (21,716) (36,059) (18,793)
Other income (expense):
Interest income, net ........................................... 663 1,308 1,858
Royalty and other income (expense), net ........................ 200 (237) 232
Write-down of investment in unaffiliated company ............... (316) -- --
---------- ---------- ----------
547 1,071 2,090
---------- ---------- ----------
Loss from continuing operations before income taxes ............... (21,169) (34,988) (16,703)
Income tax expense (benefit) ...................................... (1,119) 400 174
---------- ---------- ----------
Loss from continuing operations ................................... (20,050) (35,388) (16,877)
Gain on disposal of discontinued operations ....................... -- -- 2,304
---------- ---------- ----------
Net income (loss) ................................................. $ (20,050) $ (35,388) $ (14,573)
========== ========== ==========
Earnings (loss) per share -- basic and diluted
Continuing operations .......................................... $ (0.62) $ (1.15) $ (0.58)
Discontinued operations ........................................ -- -- 0.08
---------- ---------- ----------
Net loss ....................................................... $ (0.62) $ (1.15) $ (0.50)
========== ========== ==========
Shares used in per share calculation -- basic and diluted ......... 32,534 30,771 29,217
========== ========== ==========
The accompanying notes are an integral part of these financial statements.
28
Cylink Corporation
Consolidated Statements of Shareholders' Equity and Comprehensive Loss
(dollars in thousands)
Additional
Common Stock Paid-in Deferred
Shares Amount Capital Compensation
-------------- -------- ------------ --------------
Balance at January 1, 1999 .................... 29,115,000 $ 291 $ 123,929 $ (167)
Issuance of common stock under stock
option plans ................................. 456,000 5 936 --
Issuance of common stock and options for
S.D.I. ....................................... 306,000 3 2,031 (2,034)
Amortization of deferred compensation - ....... -- -- -- 411
Translation adjustment ........................ -- -- -- --
Net loss ...................................... -- -- -- --
Comprehensive loss ............................ -- -- -- --
---------- ----- --------- --------
Balance at December 31, 1999 .................. 29,877,000 299 126,896 (1,790)
Issuance of common stock and options for
Celotek acquisition .......................... 1,664,000 16 25,743 (545)
Issuance of common stock under stock
option and stock purchase plans .............. 1,140,000 12 6,387
Adjustment due to employee termination ........ (221) 221
Amortization of deferred compensation ......... -- 883
Translation adjustment ........................ --
Net loss ...................................... --
Comprehensive loss ............................ -- -- -- --
---------- ----- --------- --------
Balance at December 31, 2000 .................. 32,681,000 327 158,805 (1,231)
Issuance of common stock under stock
option and stock purchase plans .............. 299,000 2 197
Deferred compensation due to stock options 42
Amortization of deferred compensation ......... 528
Reversal of unamortized deferred
compensation due to sale of SDI .............. (157) 157
Transfer of unamortized deferred
compensation related to escrowed shares ...... (121,000) (546) 546
Stock compensation ............................ 13,000 18
Translation adjustment ........................
Net loss ......................................
Comprehensive loss ............................ -- -- -- --
---------- ----- --------- --------
Balance at December 31, 2001 .................. 32,872,000 $ 329 $ 158,359 $ --
========== ===== ========= ========
Accumulated
Other Comprehensive
Comprehensive Accumulated Income
Income (Loss) Deficit Total (Loss)
--------------- --------------- -------------- ----------------
Balance at January 1, 1999 .................... $ (61) $ (48,771) $ 75,221
Issuance of common stock under stock
option plans ................................. -- -- 941
Issuance of common stock and options for
S.D.I. ....................................... -- -- --
Amortization of deferred compensation - ....... -- -- 411
Translation adjustment ........................ (21) -- (21) $ (21)
Net loss ...................................... -- (14,573) (14,573) (14,573)
---------
Comprehensive loss ............................ -- -- -- $ (14,594)
----- ----------- --------- =========
Balance at December 31, 1999 .................. (82) (63,344) 61,979
Issuance of common stock and options for
Celotek acquisition .......................... 25,214
Issuance of common stock under stock
option and stock purchase plans .............. 6,399
Adjustment due to employee termination ........ --
Amortization of deferred compensation ......... 883
Translation adjustment ........................ 66 66 $ 66
Net loss ...................................... (35,388) (35,388) (35,388)
---------
Comprehensive loss ............................ -- -- -- $ (35,322)
----- ----------- --------- =========
Balance at December 31, 2000 .................. (16) (98,732) 59,153
Issuance of common stock under stock
option and stock purchase plans .............. 199
Deferred compensation due to stock options 42
Amortization of deferred compensation ......... 528
Reversal of unamortized deferred
compensation due to sale of SDI .............. --
Transfer of unamortized deferred
compensation related to escrowed shares ...... --
Stock compensation ............................ 18
Translation adjustment ........................ (2) (2) (2)
Net loss ...................................... (20,050) (20,050) (20,050)
----------
Comprehensive loss ............................ -- -- -- $ (20,052)
----- ----------- --------- ==========
Balance at December 31, 2001 .................. $ (18) $ (118,782) $ 39,888
===== =========== =========
The accompanying notes are an integral part of these financial statements.
29
Cylink Corporation
Consolidated Statements of Cash Flows
(dollars in thousands)
Twelve months ended
---------------------------------------------
December 31, December 31, December 31,
2001 2000 1999
---------------- -------------- -------------
Cash flows from operating activities:
Net loss .......................................................... $ (20,050) $ (35,388) $ (14,573)
Adjustments to reconcile net loss to net cash used in operating
activities:
Write-down of investment in unaffiliated company ................. 316 -- --
Gain on disposal of discontinued operations ...................... -- -- (2,304)
Loss on divestiture of ARL ....................................... 2,661 -- --
Loss on Disposition of Fixed Assets .............................. 76 68 337
Depreciation ..................................................... 3,369 3,782 2,657
Amortization ..................................................... 3,215 3,199 2,799
Purchased in-process research & development ...................... -- 3,681 --
Deferred income taxes ............................................ 800 3,567 128
Amortization of imputed interest on note receivable .............. (277) (231) (250)
Deferred compensation related to stock options ................... 570 883 411
Changes in operating assets and liabilities (net of effects of
acquisition and divestitures) :
Accounts receivable ............................................. 3,964 1,654 (7,927)
Inventories ..................................................... 5,510 (2,367) 3,544
Other assets .................................................... 375 390 3,036
Accounts payable ................................................ (2,024) (2,401) 2,937
Accrued liabilities ............................................. (3,078) 500 381
Income taxes payable ............................................ (8) (703) (29)
Deferred revenue ................................................ (419) 1,754 420
Restructuring reserves .......................................... 1,370 -- --
----------- ---------- ----------
Net cash used in operating activities ............................ (3,630) (21,612) (8,433)
Cash flows from investing activities:
Restricted Cash ................................................... -- -- (1,400)
Acquisition of property and equipment ............................. (694) (2,994) (7,339)
Loans to employees in exchange for notes receivable ............... (5) -- (570)
Collections of employee notes receivable .......................... 560 1,369 870
Collection of note receivable ..................................... -- -- 3,250
Cash transferred with divestiture of ARL and Security Design
International (SDI) .............................................. (1,928) -- --
Acquisition of S.D.I. ............................................. -- -- (572)
Acquisition of Celotek Corporation, net of cash acquired .......... -- (1,062) --
----------- ---------- ----------
Net cash used in investing activities ........................... (2,067) (2,687) (5,761)
----------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock, net ....................... 199 6,399 941
Other ............................................................. (144) (86) (131)
----------- ---------- ----------
Net cash provided by financing activities ....................... 55 6,313 810
----------- ---------- ----------
Effect of exchange rate changes on cash and cash equivalents ......... (2) 66 (21)
------------ ---------- ----------
Net decrease in cash and cash equivalents ............................ (5,644) (17,920) (13,405)
Cash and cash equivalents at beginning of year ....................... 15,250 33,170 46,575
----------- ---------- ----------
Cash and cash equivalents at end of year ............................. $ 9,606 $ 15,250 $ 33,170
=========== ========== ==========
Supplemental disclosures
Equity issued for purchase of Celotek ............................. -- 25,759 --
Equity issued for purchase of SDI ................................. -- -- 2,034
Cash refunds of income tax ........................................ 1,963 2,541 --
Cash paid for interest ............................................ -- -- 3
The accompanying notes are an integral part of these financial statements.
30
Cylink Corporation
Notes to Consolidated Financial Statements
1. The Company and a Summary of its Significant Accounting Policies
The Company
Cylink Corporation (the "Company") develops, manufactures, markets and
supports a comprehensive portfolio of hardware and software security products
for mission-critical private networks and business communications over the
Internet. The Company's products are incorporated into local area networks
(LANs) and wide area networks (WANs), including Virtual Private Networks (VPNs)
that use the Internet.
Basis of presentation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liablilities in the normal course of business. As shown in the financial
statements, the Company has incurred losses from continuing operations of $20
million in 2001 and $35 million in 2000, and its cash balances have declined
from $15.3 million as of December 31, 2000 to $9.6 million as of December 31,
2001. These factors among others indicate that the Company may be unable to
continue as a going concern for a reasonable period of time. The financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. To address these issues, the Company effected significant cost
cutting measures beginning in the fourth quarter of 2000, and continuing into
2001, including staff reductions and field office consolidations, divestiture of
unprofitable operations and has planned to sublease a portion of its corporate
headquarters facility. Management believes the Company will be able to continue
operations by the successful implementation of its plan to increase revenue,
continue to reduce its cost structure, maximize return on investments in
non-core areas of the business, and ultimately attain profitable operations. In
addition, the Company may seek debt or equity financing if required, however, no
assurances can be given that the Company will attain profitable operations or
that additional financing would be available.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements, and reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. These estimates include allowances for doubtful receivables,
inventory write-downs, warranty costs, and valuation allowance on deferred
assets.
Foreign currency
The functional currency of the Company's Israeli operations which were
divested in 2001 is the U.S. dollar. The functional currencies of the Company's
other foreign operations are the local currencies. The effects of translating
the financial position and results of operations of local functional currency
operations are included as a component of other comprehensive income. The
effects of foreign currency transactions and of remeasuring the financial
position and results of Israeli operations into the functional currency are
included in the statements of operations. Net gains and losses from foreign
currency transactions were not significant during any of the periods presented.
Cash and cash equivalents
Cash and cash equivalents consist of highly liquid investment instruments
with a maturity at the time of purchase of three months or less.
Inventories
Inventories are stated at the lower of standard cost (which approximates
actual cost on a first-in, first-out basis) or market.
31
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
Restricted cash
Restricted cash consists of certificates of deposit, which are restricted
from use pursuant to an operating lease obligation (Note 16).
Property and equipment
Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets,
generally three-to-five years. Amortization of leasehold improvements is
computed using the straight-line method over the shorter of the estimated useful
lives of the assets or the remaining lease term. Beginning in 1999, computer
software for internal use is capitalized in accordance with the guidelines of
Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" issued by the American Institute of
Certified Public Accountants (AICPA).
Amortization of goodwill and other intangibles
Goodwill and other intangibles are being amortized on a straight-line basis
over three to seven years. Accumulated amortization relating to goodwill and
other intangibles was $4.3 million and $9.4 million at December 31, 2001 and
2000, respectively. Intangible assets consist of acquired technology of $9.8
million (net), goodwill of $5.9 million (net) and other intangibles $0.9 million
(net) acquired in the Celotek acquisition (see Note 4). Approximately, $0.5
million in goodwill and other intangibles was written off in the divestiture of
ARL (See Note 5).
Impairment of long-lived assets
The Company periodically reviews the recoverability of all long-lived
assets, including the related amortization period, whenever events or changes in
circumstances indicate that the carrying amount of an asset might not be
recoverable. The Company determines whether there has been an impairment by
comparing the anticipated undiscounted future net cash flows to the related
asset's carrying value. If an asset is considered impaired, the asset is written
down to its estimated fair value.
Revenue recognition
The Company's revenue is derived primarily from sales of commercial network
security products, and to a lesser extent, from the license of software products
and from professional services, including customer support and consulting. Fees
for maintenance and support services of hardware products are charged separately
from product revenue. Revenues derived from the sale or license of the Company's
products are recognized in accordance with the applicable accounting standards,
including Statement of Position No. 97-2, "Software Revenue Recognition", as
amended. Revenue is recognized when persuasive evidence of a sale arrangement
exists, such as receipt of a contract or purchase order, the product has been
shipped, the sales price is fixed and determinable, collection is probable, and
vendor-specific objective evidence exists to allocate a portion of the total fee
to any undelivered elements of the arrangement. Such undelivered elements
typically consist of maintenance and support, which are deferred and amortized
over the applicable period. Vendor specific objective evidence of the value of
maintenance and support is generally based on the annual renewal rate.
Concurrent with sales, a provision is made for estimated costs to repair or
replace products under warranty arrangements. Consulting revenues, which to date
have been immaterial, are recognized on a time-and-materials or percentage of
completion basis in accordance with the provisions of Accounting Research
Bulletin-45, "Long-Term Construction-Type Contracts," and Statement of Position
81-1, "Accounting for Performance of Construction-type and Certain
Production-type Contracts" depending on the contract.
Research and development
Research and development costs are charged to operations as incurred.
32
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
From time-to-time, the Company performs research and development under
several government funded arrangements. There were no such funded arrangements
in 2001 and 2000. These contracts provide funding (irrespective of the results)
for research and development of certain cryptographic technologies. Amounts
received under these contracts are offset against research and development
expenses.
The Company performed research and development under several other research
and development contracts during 2001, 2000, and 1999, which provide for the
development and licensing of technology in exchange for development funding. The
Company recorded as a reduction of research and development expenses $0.1
million, $0.2 million and $1.5 million under such arrangements in the years
ended December 31, 2001, 2000, and 1999, respectively.
Software Development Costs
Software development costs are included in research and development and are
expensed as incurred. Statement of Financial Accounting Standards No. 86 (SFAS
86) requires the capitalization of certain development costs of software to be
sold once technological feasibility is established, which the Company defines as
completion of a working model. The capitalized cost is then amortized on a
straight-line basis over the estimated product life, or on the ratio of current
revenues to total projected product revenues, whichever is greater. To date, the
period between achieving technological feasibility and the general availability
of such software has been short and software development costs qualifying for
capitalization have been insignificant. Accordingly, the Company has not
capitalized any software development costs under SFAS 86.
Stock-based compensation
The Company accounts for stock based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations. The Company provides
additional pro forma disclosures as required under SFAS 123, "Accounting for
Stock-Based Compensation" (See Note 10).
Income taxes
Deferred tax assets and liabilities are recognized for the expected tax
consequences of temporary differences between the tax bases of assets and
liabilities and their financial statement reported amounts. A valuation
allowance is required to reduce net deferred tax assets to amounts that are more
likely than not to be realized.
Earnings (loss) per share
Basic earnings (loss) per share is based on the weighted-average number of
common shares outstanding, excluding shares in escrow related to acquisitions
(Note 4). Diluted earnings (loss) per share is based on the weighted-average
number of common shares outstanding and dilutive potential common shares
outstanding excluding contingent shares held in escrow. The Company's only
potentially dilutive securities are stock options (See Note 10). All potentially
dilutive securities have been excluded from the computation of diluted earnings
per share, as their effect is anti-dilutive on the loss from continuing
operations for all periods presented.
Concentrations of credit risk
Financial instruments that potentially subject the Company to significant
concentration of credit risk consist primarily of cash and cash equivalents,
accounts receivable, and to a lesser extent, currency fluctuation of balances
denominated in currencies other than the United States dollar. The Company
33
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
performs on-going credit evaluations and maintains reserves for estimated
potential credit losses. The Company minimizes the amount of cash it maintains
in local currencies by maintaining excess cash in United States dollars.
No customer accounted for more than 10% of revenue for the year ended
December 31, 2001. One customer accounted for 13% of revenue for the year ended
December 31, 2000 and one customer for 11% of revenue for the year ended
December 31, 1999.
Fair value of financial instruments
The carrying amount of cash and cash equivalents approximates fair value
based on the short-term nature of these instruments. The recorded amount of
long-term debt approximates fair value as the actual interest rates approximate
current competitive rates.
Dependence on suppliers
The Company's ability to timely deliver its products is dependent upon the
availability of quality components and subsystems used in these products. The
Company depends in part upon subcontractors to manufacture, assemble and deliver
certain items in a timely and satisfactory manner. The Company obtains certain
components and subsystems from single, or a limited number of sources. A
significant interruption in the delivery of such items could have a material
adverse effect on the Company's financial condition and results of operations.
Comprehensive income (loss)
Comprehensive income (loss) includes all changes in equity (net assets)
during a period from nonowner sources. Examples of items to be included in
comprehensive income, which are excluded from net income (loss), include foreign
currency translation adjustments and unrealized gain/loss on available-for-sale
securities. The Company has presented comprehensive income (loss) for each
period presented within the Consolidated Statements of Shareholders' Equity.
Reclassifications
Certain reclassifications have been made to the financial statements in
order to conform to the 2001 presentation. These reclassifications did not have
any effect on net income (loss) or on shareholders' equity.
Recently issued accounting standards
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, "Accounting for Business Combinations"
("SFAS No. 141"). SFAS No. 141 requires that all business combinations be
accounted for using the purchase method of accounting and prohibits the
pooling-of-interests method for business combinations initiated after June 30,
2001. During 2000, the Company's sole business combinations were accounted for
by using the purchase method of accounting, and there were no acquisitions
during 2001. In accordance with its adoption of SFAS No. 141, the Company will
use the purchase method of accounting for its business combinations. The Company
does not expect this statement to have a material impact on Cylink's
consolidated financial position or results of operations.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 142 changes the accounting for goodwill from an amortization
method to an impairment-only approach. Amortization of goodwill, including
goodwill recorded in past business combinations, will cease upon adoption of
this statement. In addition, this statement requires that goodwill be tested
for impairment at least annually at the reporting unit level. The Company
implemented SFAS No. 142 on January 1, 2002.
34
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
In accordance with this statement, Cylink is required to complete the
transitional goodwill impairment test by June 30, 2002. The Company is
evaluating but has not yet determined whether adoption of this statement will
result in an impairment of goodwill. Management estimates that goodwill and
indefinite lived intangible asset amortization required under previous
accounting standards of $1.0 million (pre- and post-tax) will not be charged to
the income statement in 2002.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, Accounting for Asset Retirement
Obligations ("SFAS No. 143"). SFAS No. 143 covers all legally enforceable
obligations associated with the retirement of tangible long-lived assets and
provides the accounting and reporting requirements for such obligations. SFAS
No. 143 is effective for the Company beginning January 1, 2003. Management has
not yet determined the impact that the adoption of SFAS No. 143 will have on
the Company's consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement supercedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." The statement retains the previously existing
accounting requirements related to the recognition and measurement of the
impairment of long-lived assets to be held and used while expanding the
measurement requirements of long-lived assets to be disposed of by sale to
include discontinued operations. It also expands the previously existing
reporting requirements for discontinued operations to include a component of an
entity that either has been disposed of or is classified as held for sale. SFAS
No. 144 is effective for the company as of January 1, 2002 and management does
not expect this statement to have a material impact on its consolidated
financial position or results of operations.
2. Gain on Disposal of Discontinued Operations
On March 28, 1998, the Company sold its Wireless Group to P-Com for $58.1
million ($46.0 million in cash and an unsecured note in the amount of $12.1
million). The sale resulted in an after tax gain of approximately $22.8 million
in 1998. After the elimination of other claims by Cylink against P-Com and the
offset of certain reserves against those assets, Cylink recorded an additional
$2.3 million after-tax gain on disposal of discontinued operations in 1999.
3. Restructuring Charges
In the fourth quarter of 2001, the Company recorded a $1.4 million charge
to accrue for losses relative to the estimated costs of excess leased facilities
and related furniture and equipment, net of estimated proceeds from planned
subleasing of excess office space in Santa Clara. The resulting restructuring
reserve of $1.4 million is included in accrued liabilities and other accruals on
the accompanying balance sheet as none of the reserve was paid out as of
December 31, 2001. In the second, third and fourth quarters of 2001, the Company
initiated workforce reductions affecting a total of 79 employees incurring a
total of $0.6 million in severance charges which was fully paid during 2001.
On October 30, 2000 the company announced a restructuring in order to
streamline operations and reduce costs. The Company initiated workforce
reductions of 36 employees incurring severance costs of $0.5 million before
taxes fully paid during 2000 and pre-tax lease cancellation costs of $0.3
million accrued at December 31, 2000.
4. Acquisitions
Celotek
On August 30, 2000, Cylink acquired all the outstanding shares of Celotek,
a developer of high-performance Asynchronous Transfer Mode network security
appliances. The Company exchanged
35
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
1,590,137 shares of common stock with a fair value of $22,386,000 and cash of
$515,000 for all the outstanding shares of Celotek. In addition, the Company
converted outstanding options to purchase Celotek common stock into options to
purchase 307,500 shares of common stock of the Company with an aggregate fair
value of $2,329,000. The fair value of these options were determined using the
Black-Scholes option pricing model with the following assumptions: expected life
of 2.9 years, risk-free interest rate of 6.00%, volatility of 80% and no
dividends during the expected term. The total purchase price was $26,500,000,
which included transaction costs of $1,270,000, a portion of which was satisfied
through the issuance of 33,728 shares of Cylink's common stock.
In addition, during 2001, 40,913 shares were issued to former employees of
Celotek who were employed by Cylink for twelve months following the date of
acquisition. The fair value ($545,000) of these shares was amortized to
compensation expense over the twelve month vesting term following the
acquisition date.
Of the total shares issued under the agreement, 241,572 shares of common
stock, held in escrow as collateral for general representations and warranties
made by Celotek under the agreement, were released after a period of one year
from the closing.
Assets acquired and liabilities assumed in the acquisition were as follows
(in thousands):
Current assets (including cash and cash equivalents of $253) $ 2,429
Property and equipment ...................................... 1,059
Acquired technology ......................................... 12,077
In-process technology ....................................... 3,681
Goodwill .................................................... 7,225
Other intangibles ........................................... 1,403
Current liabilities ......................................... (1,189)
Long-term debt assumed ...................................... (185)
--------
$ 26,500
========
The allocation of the purchase price to the respective intangible assets
was based on management's estimates of the after-tax cash flows. This allocation
gave explicit consideration to the Securities and Exchange Commission's view on
purchased in-process research and development as set forth in its September 9,
1998 letter to the American Institute of Certified Public Accountants.
Management's estimates gave consideration to the following: (i) the employment
of a fair market value premise excluding any Company-specific considerations
that could result in estimates of investment value for the subject assets; (ii)
comprehensive due diligence concerning all potential intangible assets; (iii)
the determination that none of the technology development had been completed at
the time of the acquisition; and (iv) the allocation to in-process research and
development based on a calculation that considered the present value of the
operating income that would have been generated by the in process research and
development project that is attributable to the acquired technology if
successfully completed.
The Company allocated $3.7 million to acquired in-process research and
development that had not reached technological feasibility as of the date of the
transaction. The acquired in-process research and development was approximately
80% complete towards development of a reduced cost asynchronous transfer mode
encryptor. The primary remaining efforts associated with the development of the
technology included several key areas. The key areas were completing the
hardware and electronics necessary to make the product functional and shock and
heat testing. The Company incurred approximately 27 person months of additional
development since acquisition and completed the initial development of the
technology in November 2000.
The values assigned to acquired in process research and development was
determined by estimating the costs to develop the purchased in-process
technology into a commercially viable product, estimating
36
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
the resulting net cash flows from the product and discounting the net cash flows
to their present value. The revenue projections used to value the acquired
in-process research and development was based on estimates of relevant market
sizes, growth factors, expected trends in technology and other factors.
Operating expenses were estimated based on historical results and anticipated
profit margins.
The rates utilized to discount the net cash flows to their present value
were based on cost of capital calculations. Due to the nature of the forecast
and risks associated with the projected growth, profitability and the
developmental nature of the product an after-tax discount rate of 30% was used
to value the in process research and development.
The discount rate was commensurate with the stage of development and the
uncertainties in the economic estimates described above. If the acquired
in-process research and development product is not commercially successful, the
Company's business, operating results and financial condition may be materially
adversely affected in future periods. In addition, the value of other intangible
assets acquired may be impaired.
The following unaudited pro forma information shows the results of
operations for the years ended December 31, 2000 and 1999, respectively, as if
the Celotek acquisition had occurred at the beginning of the earliest period
presented and at the purchase price established in October 2000 (in thousands,
except per share amounts):
Year ended December 31,
------------------------------
2000 1999
---- ----
Total revenue ............................ $ 69,567 $ 60,647
Net loss ................................. $ (39,791) $ (22,372)
Loss per share -- basic and diluted: ..... $ (1.25) $ (0.73)
Security Design International
On July 21, 1999, Cylink acquired Virginia-based SDI, a security consulting
and professional services company that provide network vulnerability
assessments. Concurrent with the acquisition, Cylink entered into employment
contracts with four SDI shareholders. In connection with the acquisition and
employment agreements, Cylink (1) paid cash of $572,000 (including $122,000 of
transaction costs), (2) issued 306,402 shares of Cylink common shares valued at
$1.7 million into escrow, to be released in annual installments as the shares
vest over a three-year employment period, (3) issued options to purchase 150,000
of Cylink common shares at $3.84 per share, which vest over four years of
continued employment, and (4) agreed to pay bonuses of up to $1.925 million
contingent upon continued employment and the achievement of specified revenue
and profitability goals during the following three years. Deferred compensation
resulting from the issuance of the escrowed common shares and the stock options
totaled $2.034 million and is reported as a reduction to shareholders' equity,
to be amortized over the applicable vesting period. The acquisition was recorded
using the purchase method, and the goodwill arising from the transaction
($436,000) is being amortized over three years. The results of operations of SDI
are included in the accompanying consolidated financial statements from the date
of acquisition through the date of sale. Revenues from SDI were insignificant in
comparison to Cylink's consolidated revenues during 1999.
On April 9, 2001, Cylink Corporation sold SDI to a private company. Of the
original consideration enumerated above, (1) 120,762 shares of the 306,402
shares issued to escrow were returned to the Company and cancelled, as SDI was
divested prior to the three year holding period contemplated by the original
purchase agreement. (2) 98,926 options of the original 150,000 options to
acquire Cylink common shares were cancelled unvested, and (3) no bonuses were
paid during the ownership period due to the failure of SDI to achieve its
financial goals. The remaining unamortized deferred compensation of
37
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
$157,000 relating to the options issued and $546,000 relating to the escrowed
shares was reversed to additional paid-in-capital at the time of the sale, as
SDI was divested prior to the three year holding period contemplated by the
original purchase agreement.
5. Divestitures
On April 9, 2001, the Company sold SDI to a private company in exchange for
209,425 shares of Series C preferred stock representing a minority interest in
that company (see Note 4). No gain or loss was recorded on the transaction. The
Company evaluated the carrying value of its investment in the preferred shares
of that private company at December 31, 2001, and recorded a charge for
impairment of the value of that investment in the amount of $0.3 million.
On June 22, 2001, the Company announced that it would close or sell its
Israeli subsidiary, Algorithmic Research, Ltd. ("ARL"). The Company recorded a
$2.5 million charge during the second quarter of 2001, resulting from the
write-down of assets associated with the wind-up of that subsidiary. On August
9, 2001, Cylink executed an Allotment and Conversion Agreement and various
related documents (collectively the "ARL Divestiture"), under which Cylink
effectively transferred ownership in ARL to ARL's existing employees. More
specifically, Cylink transferred an 81% ownership in ARL to a trustee acting on
behalf of ARL's existing employees, and converted its remaining minority
interest and its intercompany debt of approximately $13.1 million to preferred
stock of ARL having certain rights and privileges in the event of ARL's sale or
liquidation. The fair value of these preferred shares was considered to be nil
and accordingly, no value has been assigned to Cylink's ownership interest in
the preferred stock. As part of the ARL Divestiture, Cylink paid $1.5 million,
and forgave an additional $1.45 million in intercompany debt, for sale of ARL's
virtual private networking technology, a royalty free, irrevocable license to
ARL's remaining base of existing intellectual property solely for incorporating
into Cylink Products, and a release and waiver from all of ARL's existing
employees. Cylink also agreed to assign certain contracts to ARL concerning
licenses of ARL's products, and to wind up ARL's subsidiaries' operations in
Germany and Singapore. Under the ARL Divestiture, ARL will retain ownership and
responsibility for all of its other assets and liabilities. The Company incurred
an additional $0.3 million loss in connection with the divestiture during the
third quarter of 2001.
6. Working Capital Loan
On June 27, 2001, Cylink entered into a loan and security agreement with a
bank under which it may borrow up to $7.5 million by way of revolving advances.
The loan is secured by all of Cylink's tangible assets and contains a covenant
to maintain a minimum tangible net worth. The Company was in compliance with its
financial covenant at December 31, 2001, but breached it's covenant in February
2002. The revolving loan provides for loan advances up to 80% of Cylink's
eligible accounts receivable, bears interest at a rate 1.75% above the Bank's
prime rate of interest (prime was 4.75% as of December 31, 2001) and is due June
27, 2002. Cylink paid a commitment fee of $0.08 million at the inception of the
loan which is being amortized over its one-year term. There have been no
advances made under the loan since its inception.
As a result of the acquisition of Celotek, Cylink acquired an equipment
line of credit for up to $2 million. This line matures December 1, 2002 and
bears interest at the prime rate plus 1%. As of December 31, 2001, borrowings
under the equipment line were $139,000. The equipment line requires the Company
to maintain certain liquidity and profitability covenants, with which the
Company was not in compliance. Accordingly all amounts outstanding at December
31, 2001 have been classified as short term.
38
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
7. Details of Balance Sheet Components
December 31,
---------------------------
2001 2000
------------ ------------
(in thousands)
Inventories:
Raw materials ..................................... $ 2,482 $ 5,708
Work in process and subassemblies ................. 1,171 2,768
Finished goods .................................... 1,179 2,265
--------- ---------
$ 4,832 $ 10,741
========= =========
Property and equipment:
Machinery and equipment ........................... $ 9,393 $ 11,237
Leasehold improvements ............................ 3,525 3,618
Software .......................................... 2,696 2,646
Furniture and fixtures ............................ 1,870 1,996
Land and building ................................. -- 814
--------- ---------
17,484 20,311
Less: accumulated depreciation and
amortization ................................... (11,409) (10,070)
--------- ---------
$ 6,075 $ 10,241
========= =========
Accrued liabilities:
Compensation and benefits ......................... $ 2,310 $ 5,411
Legal and Accounting costs ........................ 1,028 558
Warranty costs .................................... 878 555
Restructuring provisions, current portion ......... 578 --
Distributor commissions ........................... 117 140
Employee severance costs .......................... 56 731
Royalties ......................................... 45 159
Other ............................................. 427 1,792
--------- ---------
$ 5,439 $ 9,346
========= =========
39
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
8. Income Taxes
Income tax provision (benefit) for income from continuing operations
consists of the following:
Year ended December 31,
------------------------------------------
2001 2000 1999
---- ---- ----
(in thousands)
Current:
Federal ......... $ (1,919) $ (1,096) $ 36
State ........... -- (2,071) 6
Foreign ......... -- -- 4
-------- -------- -----
$ (1,919) $ (3,167) $ 46
======== ======== =====
Deferred:
Federal ......... $ 800 $ 1,496 $ (34)
State ........... -- 2,071 (6)
Foreign ......... -- -- 168
-------- -------- -------
800 3,567 128
-------- -------- -------
$ (1,119) $ 400 $ 174
======== ======== =======
Deferred tax assets (liabilities) comprise the following:
December 31,
---------------------------
2001 2000
---- ----
(in thousands)
Assets:
Net operating loss and credit carryforwards ......... $ 20,209 $ 15,615
Inventory reserves and basis differences ............ 3,579 2,171
Accrued expenses .................................... 1,761 1,870
Product reserves .................................... 1,294 867
Warranty reserve .................................... 481 285
Bad debt reserve .................................... 197 132
Unrealized capital loss ............................. -- 1,315
Other ............................................... -- 272
--------- ---------
Total deferred tax assets ........................ 27,521 22,527
--------- ---------
Valuation allowance ................................. (27,521) (21,727)
--------- ---------
Net deferred tax assets ............................. $ -- $ 800
========= =========
Net deferred tax assets at December 31, 2001 and 2000 are based on the
Company's estimated available carryback capacity. The Company recorded a
valuation allowance against the remainder of its deferred tax assets.
At December 31, 2001, the Company has net operating loss (NOL)
carryforwards of approximately $31,029,000 and $19,561,000 for federal and state
income tax purposes, respectively. The federal NOL carryforwards expire through
2021, while the state NOL carryforwards expire through 2006.
At December 31, 2001, the Company has federal and state research credit
carryforwards of approximately $4,448,000 and $2,735,000, respectively. The
federal credits expire through 2021 and the state credits have no expiration.
In addition, the Company has state manufacturing credit carryforwards of
approximately $358,000, which expire through 2011.
40
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
The provision (benefit) for income taxes for continuing operations
reconciles to the amount computed by applying the United States federal
statutory rate to income before taxes as follows:
Year ended December 31,
--------------------------------
2001 2000 1999
---- ---- ----
U.S. federal statutory income tax rate .......... (35.0)% (35.0)% (35.0)%
State taxes, net of federal tax benefit ......... -- (5.7) (4.7)
Research and development tax credits ............ (0.8) (1.8) (4.4)
Change in valuation allowance ................... 20.3 37.6 23.8
Foreign losses not benefitted ................... 5.5 7.6 15.2
Other ........................................... 4.5 (1.7) 6.1
----- ----- -----
Effective Tax Rate .............................. (5.5)% 1.0% 1.0%
===== ===== =====
9. Preferred stock
In connection with the Company's initial public offering in 1996, the Board
of Directors authorized the issuance of up to 5,000,000 shares of undesignated
preferred stock and the Board has the authority to issue the undesignated
preferred stock in one or more series and to fix the rights, preferences,
privileges and restrictions thereof. No preferred stock had been issued as of
December 31, 2001.
10. Stock option plans
The Company has three stock option plans: the 1994 Flexible Stock Incentive
Plan which was the successor plan to the 1987 plan ("1994 Plan"), the Cylink ATM
Technology Center 2000 Stock Option Plan ("2000 Plan"), and the Cylink
Corporation 2001 Non-Qualified Stock Incentive Plan ("2001 Plan"). The 1994 Plan
provides for the grant of incentive stock options and nonqualified stock options
to executives, employees and consultants to purchase up to 8,050,000 Common
Shares. Stock options may be granted at prices not less than 100% and 85% for
incentive and nonqualified stock options, respectively, of the fair market value
of the stock on the date of grant. Through December 31, 2001, all nonqualified
stock options have been granted at or above 100% of the fair market value of the
stock on the date of grant. Options granted under the 1994 Plan are exercisable
at such times and under such conditions as determined by the Board of Directors,
and generally vest over four years. Options generally expire six years from the
date of grant.
The Company adopted the 2000 Plan in conjunction with the acquisition of
Celotek Corporation in 2000. The 2000 Plan provides for the grant of incentive
stock options and nonqualified stock options to executives, employees and
consultants to purchase up to 300,000 Cylink Common Shares.
The Company adopted the 2001 Plan in September 2001. The 2001 Plan provides
for the grant of nonqualified stock options to executives, employees and
consultants to purchase up to 2,000,000 Cylink Common Shares.
41
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
Option activity is summarized as follows:
Weighted
Shares Average
Available Options Exercise
for grant Outstanding Price
----------- ------------- -----------
(thousands of shares)
Balance at December 31, 1998 (1,746,000 shares exercisable at a
weighted average exercise price of $6.49 ) ..................... 2,399 6,100 $ 5.58
Approved ..................................................... --
Granted at market price (weighted average fair value of $3.01) (2,848) 2,847 6.35
Granted below market price (weighted average fair value
of $2.96) ................................................... (150) 150 3.84
Exercised .................................................... -- (456) 2.03
Canceled ..................................................... 1,752 (1,742) 8.36
------ ------
Balance at December 31, 1999 (2,269,000 shares exercisable at a
weighted average exercise price of $5.10) ...................... 1,153 6,899 $ 5.19
Approved ..................................................... 1,200
Granted at market price (weighted average fair value of $5.92) (3,036) 3,036 8.61
Granted above market price (weighted average fair value
of $0.23) ................................................... (59) 59 16.98
Exercised .................................................... -- (978) 5.63
Canceled ..................................................... 1,470 (1,470) 6.20
------ ------
Balance at December 31, 2000 (2,919,000 shares exercisable at a
weighted average exercise price of $5.17) ...................... 728 7,546 $ 6.39
Approved ..................................................... 1,200
Granted at market price (weighted average fair value of $0.62) (2,484) 2,484 0.88
Granted above market price (weighted average fair value
of $0.17) ................................................... (1,300) 1,300 0.54
Exercised .................................................... -- (38) 0.88
Canceled ..................................................... 3,689 (3,689) 5.80
------ ------
Balance at December 31, 2001 .................................... 1,833 7,603 $ 3.88
====== ====== ========
Significant option groups outstanding at December 31, 2001, and related
weighted average exercise price and contractual life information are as follows:
Options Outstanding Options Exercisable
----------------------------------------------------- -------------------------------
Weighted
Average
Remaining Weighted Weighted
Range of Number Contractual Life Average Number Average
Exercise Prices Outstanding (in years) Exercise Price Outstanding Exercise Price
- ------------------ ------------- ------------------ ---------------- ------------- ---------------
$ 0.01 to $ 0.54 2,741,000 5.7 $ 0.52 480,000 $ 0.41
$ 0.55 to $ 3.75 1,829,000 4.8 2.28 717,000 2.87
$ 3.81 to $ 4.25 1,136,000 3.2 4.19 922,000 4.19
$ 4.50 to $17.00 1,897,000 4.4 10.09 1,251,000 8.84
--------- ---------
7,603,000 4.8 $ 3.88 3,370,000 $ 5.10
========= =========
Pro forma stock compensation disclosures
The estimated grant date fair value disclosed by the Company is calculated
using the Black-Scholes model. The Black-Scholes model, as well as other
currently accepted option valuation models, was
42
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
developed to estimate the fair value of freely tradable, fully transferable
options without vesting restrictions, which significantly differ from the
Company's stock option awards. These models also require highly subjective
assumptions, including future stock price volatility and expected time until
exercise, which greatly affect the calculated grant date fair value.
The following weighted average assumptions are included in the estimated
grant date fair value calculations for the Company's stock option awards under
the 1994 Plan:
2001 2000 1999
---- ---- ----
Expected life (years) ............ 2.26 2.54 2.90
Risk-free interest rate .......... 3.97% 6.43% 5.39%
Volatility ....................... 134.00% 120.00% 80.00%
Dividend yield ................... 0.00% 0.00% 0.00%
Had the Company recorded compensation costs based on the estimated grant
date fair value, as defined by SFAS 123, for awards granted, the Company's net
loss and net loss per share would have been changed to the pro forma amounts
below for the years ended December 31, 2001, 2000 and 1999 (in thousands, except
for per share amounts):
Years ended December 31
------------------------------------------------
2001 2000 1999
-------------- -------------- --------------
Net loss As reported $(20,050) $(35,388) $(14,573)
Pro forma (23,858) (43,587) (21,568)
Net loss per share As reported $ (0.62) $ (1.15) $ (0.50)
-- (basic and diluted) Pro forma (0.73) (1.42) (0.74)
11. Employee Stock Purchase Plan
In January 2000, Cylink adopted an Employee Stock Purchase Plan that makes
available shares of the Company's common stock for full time employees of the
Company to purchase at a discount to the open market price through a payroll
deduction plan. From its adoption through December 31, 2001, 526,800 shares have
been made available for purchase under the Plan. Employee contributions were
limited to 12% of their base compensation during the initial five-month offering
period and 10% of their base compensation during each subsequent six-month
offering period, subject to an overall limitation of $25,000 per year. Employee
contributions that are accumulated during the offering period are used to
purchase Cylink Common Stock at the end of the offering period at a 15% discount
to the lower of the Cylink market prices at the first day and the last day of
the offering period.
12. 401K Plan
U.S. employees may participate in the The Cylink Corporation 401(k) Savings
and Retirement Plan, which was established as a supplemental retirement program.
Beginning May 1, 1987, enrollment in the 401k Plan is automatic for employees
who meet eligibility requirements unless they decline participation. Under the
401K Plan program, Cylink matches contributions by employees up at the rate of
100% of an employee's annual compensation to a maximum of $1,000.00 per year.
Cylink's expense related to the 401k Plan was $0.2 million in 2001, $0.3 million
in 2000 and nil in 1999.
13. Notes Receivable From Employees or Former Employees
During 1997, 1998 and 1999, the Company made loans to certain of its
officers towards the purchase of their principal residences. Some of these
officers are no longer employed by the Company. The notes are generally
interest free and are secured by deeds of trust on the related residences. The
Company has
43
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
imputed interest on the notes based on an assumed interest rate of 8% per annum.
One of the notes, with a face value of $558,500 was collected in full on
September 20, 2001. Another of the notes, with a face amount of $1.4 million,
was collected in full in December 2000. The remaining notes are carried at their
discounted value, which aggregated $2.0 million at December 31, 2001. As of
December 31, 2001, the remaining unamortized discount on the notes was $0.1
million. The notes mature as follows: $1.0 million in 2002, and $1.1 million in
2004.
14. Contingencies
Securities Class Action.
In 1998, we filed amended Forms 10-Q for the first and second quarters of
1998 and an amended Form 10K for 1997, reflecting restated financial results for
those quarters, and for the fourth quarter of 1997. Between November 6, 1998 and
December 14, 1998, several securities class action complaints were filed against
us and certain of our current and former directors and officers in federal
courts in California. These complaints allege, among other things, that our
previously issued financial statements were materially false and misleading and
that the defendants knew or should have known that these financial statements
caused our common stock price to rise artificially. The actions variously allege
violations of Section 10(b) of the Securities Exchange Act of 1934 (the
"Exchange Act"), as amended, and SEC Rule 10b-5 promulgated thereunder, and
Section 20 of the Exchange Act.
The securities class action lawsuits have been ordered consolidated into a
single action pending in the United States District Court for the Northern
District of California, captioned In Re Cylink Securities Litigation, No.
C98-4292 (VRW). The action is currently pending before the Court.
We believe we have meritorious defenses and adequate insurance for the
damages claimed in these actions and we intend to defend the Company vigorously.
However, it is not feasible to predict or determine the final outcome of these
proceedings, and if the outcome were to be unfavorable and exceed our applicable
insurance, our business, financial condition, cash flows and results of
operations could be materially adversely affected.
Other Litigation
In addition, in the normal course of business, we, from time to time,
receive inquiries or other communication with regard to possible infringement of
third party intellectual property rights by our patents, or the features or
content of certain of our products. We believe it is unlikely that the outcome
of these infringement inquiries will have a material adverse effect on our
financial position or results of operations, however if litigation results from
any of these inquires and the outcome is unfavorable to us, it could have a
material adverse effect on our cash flows, results of operations and financial
condition.
There has been substantial litigation regarding patent and other
intellectual property rights in the software and network security industry
related industries. Further commercialization of our products could provoke
claims of infringement from third parties. In the future, litigation may be
necessary to enforce our patents, to protect our trade secrets or know-how or to
defend against claimed infringement of the rights of others and to determine the
scope and validity of the proprietary rights of others. Any such litigation
could result in substantial cost and diversion of our efforts, which by itself
could have a material adverse effect on our financial condition and operating
results. Further, adverse determinations in such litigation could result in loss
of proprietary rights, subject us to significant liabilities to third parties,
require us to seek licenses from third parties or prevent us from manufacturing
or selling our products, any of which could have a material adverse effect on
our business, financial condition or results of operations.
44
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
15. Geographic Information
The Company operates in one reportable segment: network security. Revenue
from continuing operations and long-lived assets, classified by the major
geographic areas in which the Company operates, were as follows:
Year ended December 31,
---------------------------------------
2001 2000 1999
---- ---- ----
(in thousands)
Revenue:
Sales to unaffiliated customers:
From United States to:
Customers in United States ..................... $ 30,632 $ 41,567 $ 33,375
Customers in Central and .......................
South America .................................. 858 1,384 2,883
Customers in Europe ............................ 2,651 4,379 6,612
Customers in Asia .............................. 4,643 5,537 4,925
From Europe to customers in Europe ............... 7,332 7,758 5,662
From Israel to:
Customers in North America ..................... 56 107 112
Customers in Central and South America ......... -- 314 828
Customers in Europe ............................ 1,825 3,544 3,759
Customers in Asia .............................. 569 3,517 1,499
Other .......................................... -- -- --
-------- -------- --------
$ 48,566 $ 68,107 $ 59,655
======== ======== ========
Net sales are attributable to countries based upon shipment destination and
service location.
December 31,
-------------------------
2001 2000
---- ----
(in thousands)
Long-lived assets:
United States ....... $ 25,755 $ 29,070
Europe .............. 321 455
Israel .............. -- 1,453
-------- --------
26,076 30,978
======== ========
16. Lease Commitments
The Company leases its headquarters and manufacturing facility and sales
offices under various noncancelable operating leases. These leases expire at
various dates through August 2009 and certain of the leases are renewable for an
additional five years. In addition to the minimum lease payments, the Company is
responsible for insurance, repairs and certain other operating costs under the
terms of the leases.
Under the terms of an operating lease, the Company is required to maintain
a restricted cash deposit with a financial institution to be used as collateral
against future minimum lease allocations, until the Company reaches some defined
profitability goals.
45
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
Future minimum lease payments under all noncancelable operating leases are
as follows (in thousands):
Operating
Year ending December 31, Leases
---------------------------------- ----------
2002 ........................... $ 3,411
2003 ........................... 3,363
2004 ........................... 3,320
2005 ........................... 3,404
2006 ........................... 3,442
Subsequent to 2006 ............. 9,374
--------
Total minimum payments ......... $ 26,314
========
Rent expense under operating leases totaled $4,702,000, $4,553,000 and
$3,347,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
17. Selected Quarterly Financial Data (Unaudited)
The following table shows selected unaudited financial data for the four
quarters of 2000 and 2001.
Selected Quarterly Financial Data (Unaudited)
(in thousands except for share amounts)
April 2, July 2, Oct 1, Dec. 31,
2000 2000 2000 2000
---- ---- ---- ----
Total revenues ....................................... $ 17,738 $ 18,005 $ 17,192 $ 15,172
Gross profit ......................................... 11,277 11,572 11,019 6,998
Operating loss ....................................... (6,561) (6,540) (10,818) (12,140)
Net loss ............................................. (6,255) $ (6,093) $(10,708) $(12,332)
Basic and diluted net loss per share ................. $ (0.21) $ (0.20) $ (0.35) $ (0.39)
Shares used in computation of basic
and diluted net loss per share ...................... 30,051 30,511 31,007 31,515
April 1, July 1, Sep. 30, Dec. 31,
2001 2001 2001 2001
---- ---- ---- ----
Total revenues ....................................... $ 12,612 $ 13,571 $ 10,345 $ 12,038
Gross profit ......................................... 8,267 7,618 5,440 8,604
Operating loss ....................................... (7,303) (8,634) (5,309) (470)
Net loss ............................................. (7,132) $ (7,418) $ (4,759) $ (741)
Basic and diluted net loss per share ................. $ (0.22) $ (0.23) $ (0.15) $ (0.02)
Shares used in computation of basic
and diluted net loss per share ...................... 32,262 32,384 32,623 32,859
The above quarterly data includes revenues and expenses of ARL up to August
9, 2001, the date of its divestiture.
18. Subsequent Events
On February 8, 2002, Cylink received notice from the United States Postal
Service ("USPS") that it was terminating its license to Cylink's Net Authority
product as of March 17, 2002, noting that its decision was "not a reflection of
the quality of work performance provided by Cylink" but was due to "USPS'
immediate need to reduce cost" and downsize its non core businesses following
the anthrax attack on its
46
Cylink Corporation
Notes to Consolidated Financial Statements -- (Continued)
operations in October of 2001. Revenues from USPS during 2001 amounted to
approximately $2.0 million. The Company recently granted a continuation of USPS'
license, at its request, through May 30, 2002, but we expect this license and
all further revenue earned under Cylink's contract with the USPS to expire in
the second quarter of 2002. Although the Company continues to explore
alternative sources of funding for our PKI development activity with other
potential OEM customers, any effort to continue development and marketing of
Cylink's PKI technology may fail to generate sufficient revenue to cover its
costs if we continue in this business for the balance of 2002.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
47
PART III
Certain information required by Part III is omitted from this report
because we filed a definitive proxy statement within 120 days after the end of
our fiscal year pursuant to Regulation 14A for the Annual Meeting of
Shareholders to be held on May 16, 2001, and the information included therein is
incorporated by reference herein to the extent detailed below.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is included under "Proposal No. 1:
Election of Directors," "Other Information -- Executive Officers" and
"Compliance with Section 16(a) of the Exchange Act" in our Proxy Statement to be
filed in connection with our 2002 Annual Meeting of Shareholders and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is included under "Other
Information--Executive Compensation" in our Proxy Statement to be filed in
connection with our 2002 Annual Meeting of Shareholders and is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is included under "Other
Information--Security Ownership of Certain Beneficial Owners and Management" in
our Proxy Statement to be filed in connection with our 2002 Annual Meeting of
Shareholders and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is included under "Other
Information--Certain Transactions" in our Proxy Statement to be filed in
connection with our 2002 Annual Meeting of Shareholders and is incorporated
herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements -- Please see the accompanying Index to
Consolidated Financial Statements and Financial Statement Schedule,
which appear on page 25 of this Report on Form 10-K.
2. Financial Statement Schedule -- Please see the accompanying Index to
Consolidated Financial Statements and Financial Statement Schedule
listed on page 25 of this Report on Form 10-K.
3. Exhibits Index: The Exhibits listed in the accompanying Index to
Exhibits are filed or incorporated by reference as part of this
Annual Report 10-K.
(b) Reports on Form 8-K. None filed during the fourth quarter ended
December 31, 2001.
-
48
INDEX TO EXHIBITS
Item 14(a)) Description of Exhibit
Exhibit
- -----------
2.1 Agreement and Plan of Reorganization by and between Cylink Corporation and
Celotek Corporation, dated as of July 27, 2000. (1)
2.2 Agreement and Plan of Reorganization by and among Cylink Corporation, Star
Acquisition Corporation and Security Design International, Inc., dated as of June
25, 1999.
3.1 Amended and Restated Articles of Incorporation of the Registrant and Certificate of
Amendment thereto dated March 5, 1996. (2)
3.2 Bylaws, as amended. (2)
3.3 Certificates of Amendment of the Bylaws dated March 26, 1997. (3)
4.1 Reference is made to Exhibits 3.1, 3.2, and 3.3.
4.2 Specimen certificate for Common Stock. (2)
10.1 Form of Indemnification Agreement between the Company and each of its executive
officers and directors. (2)
10.2 Severance Agreement between the Company and Fernand B. Sarrat, dated as of
November 3, 1998. (3) (4)
10.3 Employment Agreement between the Company and William C. Crowell dated
December 18, 1997, and restated as of September 1, 2001. (3)
10.4 Company's 1994 Flexible Stock Incentive Plan, including forms of agreements
thereunder, and amendments thereto. (2) (3)
10.5 Lease dated May 10, 1999 by and between Orchard Jay Investors, LLC
and David Brown as Landlord and Cylink Corporation, as tenant, as
amended August 5, 1999.
21.1 Subsidiaries of the Company.
23.1 Consent of Deloitte & Touche LLP.
24.1 Power of Attorney. Reference is made to Page IV-2.
- ------------
(1) Incorporated by reference from the Company's reports on Form 8-K filed as of
August 4, 2000 and September 11, 2000.
(2) Incorporated by reference from the Company's Registration Statement on Form
S-1 Registration No. 33-80719, which became effective February 15, 1996.
(3) Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this report on Form 10-K pursuant to Item 14(a).
(4) Incorporated by reference from the Company's report on Form 10-K filed as of
March 31, 1997 for the fiscal year ended December 31, 1996. Incorporated by
reference from the Company's report on Form 10-K filed as of March 31, 1997
for the fiscal year ended December 31, 1996.
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CYLINK CORPORATION
Date: March 28, 2002 By: /s/ William P. Crowell
---------------------------------------
William P. Crowell
President and Chief Executive Officer
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints R. Christopher Chillingworth and Robert
B. Fougner, and each of them, acting individually, as his or her
attorney-in-fact, each with full power of substitution and resubstitution, for
him and in his name, place and stead, in any and all capacities, to sign any and
all amendments to this Report on Form 10-K, and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection therewith
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ WILLIAM P. CROWELL President, Chief executive Officer March 28, 2002
- ----------------------------------- (Principal Executive Officer)
William P. Crowell and Director
/s/ R. CHRISTOPHER CHILLINGWORTH Vice President of Finance and Chief March 28, 2002
- ----------------------------------- Financial Officer (Principal
R. Christopher Chillingworth Financial and Accounting Officer)
/s/ LEO A. GUTHART Chairman of the Board March 28, 2002
- -----------------------------------
Leo A. Guthart
/s/ ELWYN BERLEKAMP Director March 28, 2002
- -----------------------------------
Elwyn Berlekamp
/s/ PAUL GAUVREAU Director March 28, 2002
- -----------------------------------
Paul Gauvreau
/s/ WILLIAM W. HARRIS Director March 28, 2002
- -----------------------------------
William W. Harris
/s/ HOWARD L. MORGAN Director March 28, 2002
- -----------------------------------
Howard L. Morgan
50
SCHEDULE II
CYLINK CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 1999, 2000 and 2001
(in thousands)
Additions
Balance at Charged to Deductions Balance
Beginning Statement of from at end
of Year Operations Reserves of Year
------------ -------------- ------------ --------
Allowance for doubtful accounts:
Year ended December 31, 1999 ......... $ 1,251 $ 525 $ 835 $ 941
Year ended December 31, 2000 ......... 941 874 316 1,499
Year ended December 31, 2001 ......... 1,499 268 710 1,057
51
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements
Nos. 333-65746 and 333-70242 of Cylink Corporation, on Form S-8 of our report
dated February 8, 2002 (which expresses an unqualified opinion and includes an
explanatory paragraph regarding a going concern uncertainty) appearing in this
Annual Report on Form 10-K of Cylink Corporation for the year ended December 31,
2001.
/s/ DELOITTE & TOUCHE LLP
San Jose, California
March 28, 2002
52